Advanced Search
MyIDEAS: Login to save this paper or follow this series

Dynamic inconsistencies: counterfactual implications of a class of rational expectations models

Contents:

Author Info

  • Arturo Extrella
  • Jeffrey C. Fuhrer

Abstract

A number of recent papers have developed dynamic macroeconomic models that incorporate rational expectations and optimizing foundations. While the theoretical motivation behind these models is sound, the dynamic implications of many of the specifications that assume rational expectations and optimizing behavior can be seriously at odds with the data, for both inflation and real-side variables exhibit gradual and "hump-shaped" responses to real and monetary shocks. For models that are intended for monetary policy analysis, these dynamic shortcomings should be considered quite serious. When monetary policy has only short-run effects on real variables, the inability to approximately capture the short-run responses of inflation or real variables to policy shocks makes a model unsuitable for policy analysis. This paper identifies a simple feature common to many dynamic specifications for prices and real variables that causes the problem. The paper also discusses several potential solutions to the problem, including alterations to the expectations assumption, to the order of differencing implicit in the model, and to the underlying behavioral assumptions.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.bostonfed.org/economic/wp/wp1998/wp98_5.htm
Download Restriction: no

File URL: http://www.bostonfed.org/economic/wp/wp1998/wp98_5.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 98-5.

as in new window
Length:
Date of creation: 1998
Date of revision:
Handle: RePEc:fip:fedbwp:98-5

Contact details of provider:
Postal: 600 Atlantic Avenue, Boston, Massachusetts 02210
Phone: 617-973-3397
Fax: 617-973-4221
Email:
Web page: http://www.bos.frb.org/
More information through EDIRC

Order Information:
Email:

Related research

Keywords: Econometric models;

Other versions of this item:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  2. Nelson, E., 1998. "Sluggish inflation and optimizing models of the business cycle," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 303-322, July.
  3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  4. Mankiw, N Gregory, 1985. "Consumer Durables and the Real Interest Rate," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 353-62, August.
  5. Davidson, Russell & MacKinnon, James G., 1993. "Estimation and Inference in Econometrics," OUP Catalogue, Oxford University Press, number 9780195060119, October.
  6. repec:fth:harver:1435 is not listed on IDEAS
  7. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  8. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
  9. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  10. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  11. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  12. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  13. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  14. Fuhrer, Jeff & Moore, George, 1992. "Monetary policy rules and the indicator properties of asset prices," Journal of Monetary Economics, Elsevier, vol. 29(2), pages 303-336, April.
  15. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
  16. Jeffrey C. Fuhrer, 1998. "An Optimising Model for Monetary Policy Analysis: Can Habit Formation Help?," RBA Research Discussion Papers rdp9812, Reserve Bank of Australia.
  17. Julio Rotemberg, 1987. "The New Keynesian Microfoundations," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 69-116 National Bureau of Economic Research, Inc.
  18. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series 95-42, Board of Governors of the Federal Reserve System (U.S.).
  19. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  20. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  21. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  22. Laurence Ball, 1991. "The Genesis of Inflation and the Costs of Disinflation," NBER Working Papers 3621, National Bureau of Economic Research, Inc.
  23. William Poole, 1999. "Monetary policy rules?," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 3-12.
  24. Arturo Estrella, 1997. "Why do interest rates predict macro outcomes?: A unified theory of inflation, output, interest and policy," Research Paper 9717, Federal Reserve Bank of New York.
  25. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
  26. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  27. Edmund Phelps, 1978. "Disinflation without recession: Adaptive guideposts and monetary policy," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 783-809, December.
  28. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  29. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  30. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1994. "Identification and the effects of monetary policy shocks," Working Paper Series, Macroeconomic Issues 94-7, Federal Reserve Bank of Chicago.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:fip:fedbwp:98-5. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Catherine Spozio).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.