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

  • Stephen J. Cole (a1) and Fabio Milani (a2)
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.

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Corresponding author
Address correspondence to: Fabio Milani, Department of Economics, University of California, Irvine, 3151 Social Science Plaza, Irvine, CA 92697-5100, USA; e-mail: fmilani@uci.edu; URL: http://www.socsci.uci.edu/~fmilani.
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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.

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This list contains references from the content that can be linked to their source. For a full set of references and notes please see the PDF or HTML where available.

K. Adam and M. Padula (2011) Inflation dynamics and subjective expectations in the United States. Economic Inquiry 49 (1), 1325.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
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