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Are Inflation Expectations Rational?

Author

Listed:
  • David Andolfatto

    (Simon Fraser University, Canada and The Rimini Centre for Economics Analysis, Italy)

  • Scott Hendry

    (Bank of Canada, Canada)

  • Kevin Moran

    () (Université Laval, Canada)

Abstract

Several recent papers report evidence of an apparent statistical bias in inflation expectations and interpret these findings as overturning the rational expectations hypothesis. In this paper, we investigate the validity of such an interpretation. We present a computational dynamic general equilibrium model capable of generating aggregate behavior similar to the data along several dimensions. By construction, model agents form "rational" expectations. We run a standard regression on equilibrium realizations of inflation and inflation expectations over sample periods corresponding to those tests performed on actual data and find evidence of an apparent bias in inflation expectations. Our experiments suggest that this incorrect inference is largely the product of a small sample problem, exacerbated by short-run learning dynamics in response to infrequent shifts in monetary policy regimes.

Suggested Citation

  • David Andolfatto & Scott Hendry & Kevin Moran, 2007. "Are Inflation Expectations Rational?," Working Paper series 27_07, Rimini Centre for Economic Analysis.
  • Handle: RePEc:rim:rimwps:27_07
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Regime changes; Learning dynamics; Monte Carlo experiments; Sample size;

    JEL classification:

    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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