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Are Inflation Expectations Rational?

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Author Info

  • David Andolfatto

    (Simon Fraser University, Canada and The Rimini Centre for Economics Analysis, Italy.)

  • Scott Hendry

    (Bank of Canada, Canada)

  • Kevin Moran

    ()
    (UniversitŽ Laval, Canada)

Abstract

Several recent papers report evidence of an apparent statistical bias in inflation expectations and interpret these findings as overturning the rational expectations hypothesis. In this paper, we investigate the validity of such an interpretation. We present a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along several dimensions. By construction, model agents form "rational" expectations. We run a standard regression on equilibrium realizations of inflation and inflation expectations over sample periods corresponding to those tests performed on actual data and find evidence of an apparent bias in inflation expectations. Our experiments suggest that this incorrect inference is largely the product of a small sample problem, exacerbated by short-run learning dynamics in response to infrequent shifts in monetary policy regimes.

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Bibliographic Info

Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 27-07.

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Date of creation: Jul 2007
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Handle: RePEc:rim:rimwps:27-07

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Keywords: Regime changes; Learning dynamics; Monte Carlo exp eriments; Sample size.;

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References

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