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Learning to Forecast and Cyclical Behavior of Output and Inflation

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Author Info
Klaus Adam () (Goethe University Frankfurt)

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Abstract

This paper considers a sticky price model with a cash-in-advance constraint where agents forecast inflation rates with the help of econometric models. Agents use least squares learning to estimate two competing models of which one is consistent with rational expectations once learning is complete. When past performance governs the choice of forecast model, agents may prefer to use the inconsistent forecast model, which generates an equilibrium where forecasts are inefficient. While average output and inflation result the same as under rational expectations, higher moments differ substantially: output and inflation show persistence, inflation responds sluggishly to nominal disturbances, and the dynamic correlations of output and inflation match U.S. data surprisingly well.

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Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2003/01.

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Length: 47 pages
Date of creation: 01 Jan 2003
Date of revision:
Handle: RePEc:cfs:cfswop:wp200301

Note: I am grateful to Giuseppe Bertola, Matthias Brückner, Benjamin Friedman, Tullio Jappelli, Jordi Gali, Soeren Johansen, Albert Marcet, Ramon Marimon, Athanasios Orphanides, Philippe Weil and seminar participants at Bocconi, Harvard, ECB, European University Institute, FED, MIT, Pompeu Fabra, and ULB. All errors are mine.
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Related research
Keywords: Learning; Business Cycles; Rational Expectations; Inefficient Forecasts; Output and Inflation Persistence;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation

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  1. Fabio Milani, 2008. "Learning about the Interdependence between the Macroeconomy and the Stock Market," Working Papers 070819, University of California-Irvine, Department of Economics. [Downloadable!]
  2. Eran Guse, 2007. "Learning in a Misspecified Multivariate Self-Referential Linear Stochastic Model," Money Macro and Finance (MMF) Research Group Conference 2006 71, Money Macro and Finance Research Group. [Downloadable!]
    Other versions:
  3. Wiliam Branch & George W. Evans, 2005. "Model Uncertainty and Endogenous Volatility," University of Oregon Economics Department Working Papers 2005-21, University of Oregon Economics Department, revised 26 Oct 2006. [Downloadable!]
    Other versions:
  4. Fabio Milani, 2007. "Political Business Cycles in the New Keynesian Model," Working Papers 070805, University of California-Irvine, Department of Economics. [Downloadable!]
  5. Fabio Milani, 2009. "The Effect of Global Output on U.S. Inflation and Inflation Expectations: A Structural Estimation," Working Papers 080920, University of California-Irvine, Department of Economics. [Downloadable!]
  6. Fabio Milani, 2009. "Expectations, Learning, and the Changing Relationship between Oil Prices and the Macroeconomy," Working Papers 080923, University of California-Irvine, Department of Economics. [Downloadable!]
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