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THE MISSPECIFICATION OF EXPECTATIONS IN NEW KEYNESIAN MODELS: A DSGE-VAR APPROACH

Published online by Cambridge University Press:  11 July 2017

Stephen J. Cole  and
Fabio Milani
Stephen J. Cole
Affiliation:
Marquette University
Fabio Milani*
Affiliation:
University of California, Irvine
*
Address correspondence to: Fabio Milani, Department of Economics, University of California, Irvine, 3151 Social Science Plaza, Irvine, CA 92697-5100, USA; e-mail: [email protected]; URL: http://www.socsci.uci.edu/~fmilani.
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Abstract

This paper tests the ability of New Keynesian models to match the data regarding a key channel for monetary transmission: the dynamic interactions between macroeconomic variables and their corresponding expectations. We exploit survey expectations data and adopt a dynamic stochastic general equilibrium (DSGE)-VAR approach to assess the extent and sources of model misspecification. The results point to serious misspecification in the expectations-formation side of the DSGE model. The rational expectations hypothesis is primarily responsible for the model's failure to capture the co-movements between observed macroeconomic expectations and realizations. Alternative models of expectations formation help partially reconcile the New Keynesian model with the data.

Keywords

Modeling of ExpectationsDSGE ModelsRational ExpectationsObserved Survey ExpectationsModel MisspecificationDSGE-VARHeterogeneous Expectations
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 3 , April 2019 , pp. 974 - 1007
Copyright
Copyright © Cambridge University Press 2017 

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Footnotes

We would like to thank the journal editor William Barnett, an associate editor, and two anonymous referees, for helpful comments and suggestions that substantially improved the paper.

References

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