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Predictable Forecast Errors in Full-Information Rational Expectations Models with Regime Shifts

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  • Ina Hajdini
  • Andre Kurmann

Abstract

This paper shows that regime shifts in Full-Information Rational Expectations (FIRE) models generate predictable regime-dependent forecast errors in macro aggregates. Hence, forecast error predictability alone is neither sufficient to reject FIRE nor informative about alternative expectations theories. We instead propose a regime-robust test of FIRE and apply it to a medium-scale New Keynesian model with monetary policy regime shifts that is estimated on US data. While the test fails to decisively reject FIRE, the model conditional on macro data implies expectations that are generally different from observed survey forecasts, thus providing a new empirical motivation for alternative expectations theories.

Suggested Citation

  • Ina Hajdini & Andre Kurmann, 2024. "Predictable Forecast Errors in Full-Information Rational Expectations Models with Regime Shifts," Working Papers 24-08, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwq:98054
    DOI: 10.26509/frbc-wp-202408
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    1. Alexandre N. Kohlhas & Ansgar Walther, 2021. "Asymmetric Attention," American Economic Review, American Economic Association, vol. 111(9), pages 2879-2925, September.
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    Cited by:

    1. Rychalovska, Yuliya & Slobodyan, Sergey & Wouters, Raf, 2025. "Survey expectations, learning and inflation dynamics," European Economic Review, Elsevier, vol. 180(C).
    2. Alexandros Botsis & Christoph Görtz & Plutarchos Sakellaris, 2020. "Quantifying Qualitative Survey Data: New Insights on the (Ir)Rationality of Firms' Forecasts," CESifo Working Paper Series 8148, CESifo.
    3. Todd E. Clark & Gergely Ganics & Elmar Mertens, 2022. "Constructing Fan Charts from the Ragged Edge of SPF Forecasts," Working Papers 22-36, Federal Reserve Bank of Cleveland.
    4. Rychalovska, Yuliya & Slobodyan, Sergey & Wouters, Rafael, 2026. "Professional survey forecasts and expectations in DSGE models," Journal of Monetary Economics, Elsevier, vol. 158(C).
    5. Kenneth Eva & Fabian Winkler, 2023. "A Comprehensive Empirical Evaluation of Biases in Expectation Formation," Finance and Economics Discussion Series 2023-042, Board of Governors of the Federal Reserve System (U.S.).

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    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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