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Estimating a small DSGE model under rational and measured expectations: some comparisons

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  • Paloviita, Maritta

    ()
    (Bank of Finland Research)

Abstract

Using European panel data and GMM system estimation, we explore the empirical performance of the standard three-equation New Keynesian macro model under different informational assumptions. As a benchmark, we consider the performance of the model under rational expectations and revised (final) data. Alternatively, instead of imposing rational expectations hypothesis we use real- time information, ie Consensus Economics survey data, to generate empirical proxies for expectations in the model and the current output gap in the Taylor rule. We demonstrate that, contrary to the assumption of rational expectations, the errors in measured expectations and real-time current output gaps are positively autocorrelated. We produce evidence that the use of real-time variables (including measured expectations) improves the empirical performance of the New Keynesian model. Relaxation of the rational expectations hypothesis makes a noticeable difference for the parameters of the New Keynesian model, especially in the Taylor rule.

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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 14/2007.

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Length: 30 pages
Date of creation: 03 Oct 2007
Date of revision:
Handle: RePEc:hhs:bofrdp:2007_014

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: DSGE model; survey expectations; GMM system estimation; expectations; estimation;

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  1. Adam, Klaus, 2004. "Optimal Monetary Policy with Imperfect Common Knowledge," CEPR Discussion Papers 4594, C.E.P.R. Discussion Papers.
  2. Bennett T. McCallum & Edward Nelson, 1999. "Performance of Operational Policy Rules in an Estimated Semiclassical Structural Model," NBER Chapters, in: Monetary Policy Rules, pages 15-56 National Bureau of Economic Research, Inc.
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  4. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Paloviita, Maritta & Mayes, David, 2004. "The use of real-time information in Phillips curve relationships for the euro area," Discussion Paper Series 1: Economic Studies 2004,28, Deutsche Bundesbank, Research Centre.
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  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  12. Maritta Paloviita, 2006. "Inflation Dynamics in the Euro Area and the Role of Expectations," Empirical Economics, Springer, vol. 31(4), pages 847-860, November.
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  16. Athanasios Orphanides & Simon Van_Norden, 2000. "The Reliability of Output Gap Estimates in Real Time," Econometric Society World Congress 2000 Contributed Papers 0768, Econometric Society.
  17. Maritta Paloviita & Matti Virén, 2005. "The role of expectations in the inflation process in the euro area," Macroeconomics 0508031, EconWPA.
  18. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
  19. 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.
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  21. Athanasios Orphanides and Simon van Norden, 2001. "The Reliability of Inflation Forecasts Based on Output Gaps in Real Time," Computing in Economics and Finance 2001 247, Society for Computational Economics.
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  23. Rabanal, Pau & Rubio-Ramirez, Juan F., 2005. "Comparing New Keynesian models of the business cycle: A Bayesian approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1151-1166, September.
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