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Are Inflation Expectations Rational?

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Author Info
David Andolfatto (Simon Fraser University)
Scott Hendry (Bank of Canada)
Kevin Moran (Universite Laval)

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Abstract

Simple econometric tests reported in the literature consistently report what appears to be a bias in inflation expectations. These results are commonly interpreted as constituting evidence overturning the hypothesis of rational expectations. In this paper, we investigate the validity of such an interpretation. The main tool utilized in our investigation is a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along a number of dimensions. By construction, the model embedded the assumption of rational expectations. Standard regressions run on equilibrium realizations of inflation and inflation expectations nevertheless reveal an apparent bias in inflation expectations. In these simulations, the null hypothesis of rational expectations is incorrectly rejected in a large percentage of cases; a result that casts some doubt on conventional interpretations of the evidence.

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Paper provided by EconWPA in its series Macroeconomics with number 0501002.

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Length: 28 pages
Date of creation: 04 Jan 2005
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Handle: RePEc:wpa:wuwpma:0501002

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E - Macroeconomics and Monetary Economics

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Cited by:
(explanations, 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.)

  1. Melecky, Martin & Rodrıguez Palenzuela, Diego & Soderstrom, Ulf, 2008. "Inflation Target Transparency and the Macroeconomy," MPRA Paper 10545, University Library of Munich, Germany. [Downloadable!]
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  2. Christopher J. Neely & David E. Rapach, 2008. "Real interest rate persistence: evidence and implications," Working Papers 2008-018, Federal Reserve Bank of St. Louis. [Downloadable!]
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