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Do expectations matter? The Great Moderation revisited

We examine the role of expectations in the Great Moderation episode. We derive theoretical restrictions in a New-Keynesian model and test them using measures of expectations obtained from survey data, the Greenbook and bond markets. Expectations explain the dynamics of inflation and of interest rates but their importance is roughly unchanged over time. Systems with and without expectations display similar reduced form characteristics. Including or excluding expectations hardly changes the economic explanation of the Great Moderation. Results are robust to changes in the structure of the empirical model.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1084.

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Date of creation: Nov 2007
Date of revision: Jan 2009
Handle: RePEc:upf:upfgen:1084
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