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How Should News Shocks Be Specified Under Rational Expectations?

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Abstract

A number of studies have found that news shocks account for a large part of the aggregate fluctuations of the main macroeconomic variables. We show that when taking rational expectations into consideration there is a limit on the size of the variance of the news shocks, which has not been considered in the literature. We offer an explanation to why this restriction should be imposed and show, with an empirical example from a recent paper, that if you do impose the rational expectations restriction the importance of the news is drastically reduced.

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  • Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2017. "How Should News Shocks Be Specified Under Rational Expectations?," Cardiff Economics Working Papers E2017/7, Cardiff University, Cardiff Business School, Economics Section.
    • Handle: RePEc:cdf:wpaper:2017/7
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    References listed on IDEAS

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    1. Kamber, Güneş & Theodoridis, Konstantinos & Thoenissen, Christoph, 2017. "News-driven business cycles in small open economies," Journal of International Economics, Elsevier, vol. 105(C), pages 77-89.
    2. Hashmat Khan & John Tsoukalas, 2012. "The Quantitative Importance of News Shocks in Estimated DSGE Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(8), pages 1535-1561, December.
    3. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2016. "A note on news about the future: the impact on DSGE models and their VAR representation," Cardiff Economics Working Papers E2016/11, Cardiff University, Cardiff Business School, Economics Section.
    4. Ippei Fujiwara & Yasuo Hirose & Mototsugu Shintani, 2011. "Can News Be a Major Source of Aggregate Fluctuations? A Bayesian DSGE Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(1), pages 1-29, February.
    5. Liu, Chunping & Minford, Patrick, 2014. "Comparing behavioural and rational expectations for the US post-war economy," Economic Modelling, Elsevier, vol. 43(C), pages 407-415.
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    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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