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Expectations and the effects of monetary policy

  • Laurence Ball
  • Dean Croushore

This paper examines the predictive power of shifts in monetary policy, as measured by changes in the real federal funds rate, for output, inflation, and survey expectations of these variables. We find that policy shifts have larger effects on actual output than on expected output; thus, policy predicts errors in output expectations, a violation of rational expectations. Policy shifts do not predict errors in inflation expectations. We explain these results with a model in which agents systematically underestimate the effects of policy on aggregate demand. This model helps to explain the real effects of policy.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 95-22.

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Date of creation: 1995
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Handle: RePEc:fip:fedpwp:95-22
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  1. Zarnowitz, Victor, 1985. "Rational Expectations and Macroeconomic Forecasts," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(4), pages 293-311, October.
  2. Bonham, Carl & Cohen, Richard, 1995. "Testing the Rationality of Price Forecasts: Comment," American Economic Review, American Economic Association, vol. 85(1), pages 284-89, March.
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  4. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, vol. 19(1), pages 3-24, January.
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  19. Thomas Sargent & Noah Williams & Tao Zha, 2006. "The conquest of South American inflation," Working Paper 2006-20, Federal Reserve Bank of Atlanta.
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  28. Michael C. Lovell, 1959. "Manufacturers' Inventories, Sales Expectations, and the Acceleration Principle," Cowles Foundation Discussion Papers 86, Cowles Foundation for Research in Economics, Yale University.
  29. Laurence Ball & Stephen G. Cecchetti, 1990. "Inflation and Uncertainty at Long and Short Horizons," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 215-254.
  30. John A. Carlson, 1977. "A Study of Price Forecasts," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 6, number 1, pages 27-56 National Bureau of Economic Research, Inc.
  31. Herb Taylor, 1992. "The Livingston Surveys: a history of hopes and fears," Business Review, Federal Reserve Bank of Philadelphia, issue Jan, pages 15-27.
  32. Romer, Christina D. & Romer, David H., 1994. "Monetary policy matters," Journal of Monetary Economics, Elsevier, vol. 34(1), pages 75-88, August.
  33. Dean Croushore, 1993. "Introducing: the survey of professional forecasters," Business Review, Federal Reserve Bank of Philadelphia, issue Nov, pages 3-15.
  34. Keane, Michael & Runkle, David E, 1995. "Testing the Rationality of Price Forecasts: Reply," American Economic Review, American Economic Association, vol. 85(1), pages 290, March.
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  37. Batchelor, Roy & Dua, Pami, 1991. "Blue Chip Rationality Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(4), pages 692-705, November.
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