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The permanent-transitory confusion: Implications for tests of market efficiency and for expected inflation during turbulent and

Author

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  • Cukierman, Alex
  • Lustenberger, Thomas
  • Meltzer, Allan H.

Abstract

Even when all past and present information is known individuals usually remain uncertain about the permanence of observed variables. After reviewing the history and role of adaptive expectations and its statistical foundations in modeling this permanent-transitory confusion the paper investigates the consequences of this confusion for tests of market efficiency in the treasury bill and foreign exchange markets. A central result is that the detection of serial correlation in efficiency tests based on finite samples does not necessarily imply that markets are inefficient. The second part of the paper utilizes data on Israeli inflation expectations from the capital market to estimate the implicit speed of learning about changes in inflation and to examine the performance of adaptive expectations in tracking the evolution of those expectations during the 1985 Israeli shock stabilization as well as during the stable inflation targeting period.

Suggested Citation

  • Cukierman, Alex & Lustenberger, Thomas & Meltzer, Allan H., 2018. "The permanent-transitory confusion: Implications for tests of market efficiency and for expected inflation during turbulent and," CEPR Discussion Papers 13187, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:13187
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    References listed on IDEAS

    as
    1. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    2. Cukierman, Alex & Melnick, Rafi, 2015. "The Conquest of Israeli Inflation and Current Policy Dilemmas," CEPR Discussion Papers 10955, C.E.P.R. Discussion Papers.
    3. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    4. Michael Bruno & Guido Di Tella & Rudiger Dornbusch & Stanley Fischer, 1988. "Inflation Stabilization: The Experience of Israel, Argentina, Brazil, Bolivia, and Mexico," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022796, December.
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    Cited by:

    1. Assaf Razin, 2019. "The Struggle Toward Macroeconomic Stability: An Analytical Essay," Israel Economic Review, Bank of Israel, vol. 17(1), pages 1-38.
    2. Giuliano, Fernando & Luttini, Emiliano, 2020. "Import prices and invoice currency: Evidence from Chile," Journal of International Money and Finance, Elsevier, vol. 106(C).

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    More about this item

    Keywords

    Permanent-transitory confusion and rational expectations; Tests of market efficiency in treasury bills and forex markets; Behavior of inflationary expectations during stabilizations and tranquil times;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • B16 - Schools of Economic Thought and Methodology - - History of Economic Thought through 1925 - - - Quantitative and Mathematical
    • B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics

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