Forecasting,rational expectations and the phillips-curve: An empirical investigation

The rational-expectations version of the Phillips-curve is empirically evaluated for Switzerland using a wide variety of specifications. It turns out that the results are highly sensitive to measurement of both the natural rate and expectations of nominal variables. No reliable Phillips-curve seems to exist. In addition, information on the relative quality of different forecasting schemes is obtained for a number of important macroeconomic variables.     

A rational expectations equilibrium model of urban growth and land markets

This paper presents a simple model of urban spatial growth under uncertainty with an infinite time horizon. The rational expectations equilibrium path (REE path) of the urban land market is obtained in explicit form as a function of exogenously given stochastic processes of future population, transport and household income in the city. Spatial and temporal characteristics of asset prices along the REE path are examined in detail.     

Buyers' and sellers' markets: A simple rational expectations search model of the housing market

The terms buyers' market and sellers' market are commonly used in contexts that most economists would characterize as excess supply and excess demand. It is puzzling, however, that in many instances the press and general public are all aware that it is a buyers' or sellers' market. Are these markets really that inefficient? We offer definitions of buyers' and sellers' markets that are consistent with a full rational expectations equilibrium in a simple general equilibrium search model of a heterogeneous durable goods market.     

A note on non-uniqueness in rational expectations models

McCallum has proposed a solution procedure for rational expectations models - undetermined coefficients with the minimal set of state variables - which can avoid the non-uniqueness problem. This procedure often requires some additional restrictions on the admissible values of the structural parameters. In this note we show that in some cases, these parameter restrictions may be defended with less ambiguity by considering the dynamics of the model, rather than examining particular parameter values, as suggested by McCallum.     

Estimation of a rational expectations model of the term structure

This paper shows how to represent a vector autoregression (VAR) in terms of the eigenvalues and eigenvectors of its companion matrix. This representation is used to impose the exact restrictions implied by the expectations hypothesis on the VAR for short and long term interest rates and to calculate the restricted maximum likelihood estimates. The first difference representation for short and long rates used by Sargent (1979) is shown to be inconsistent with the expectations hypothesis, but a VAR with two unit roots is constructed that satisfies the exact restrictions and leads to similar restricted estimates.     

A rational expectations equilibrium model of inventories of finished goods and employment

A critical roadblock to modeling inventories of finished goods has been the claim that the production and inventory decisions of a perfectly competitive firm are determined independently of each other. A basic goal of this study is to specify fundamental preferences of economic agents, technologies, constraints and market structures that are, in a rough way, capable of generating patterns of serial correlations and cross correlations between inventories and employment of factors of production that are consistent with those observed in the data. The claim is made that the time series for inventories, output and employment can, in principle, be interpreted as emerging from a well-specified dynamic, stochastic competitive equilibrium in which economic agents are assumed to form rational expectations about variables not included in their information sets. Inventories and employment will not be related in a direct way if and only if the price elasticity of demand for output is equal to infinity.     

On non-uniqueness in rational expectations models: An attempt at perspective

Many macroeconomic models involving rational expectations give rise to an infinity of solution paths, even when the models are linear in all variables. Some writers have suggested that this non-uniqueness constitutes a serious weakness for the rational expectations hypothesis. One purpose of the present paper is to argue that the non-uniqueness in question is not properly attributable to the rationality hypothesis but, instead, is a general feature of dynamic models involving expectations. It is also argued that there typically exists in a very wide class of linear rational expectations models, a single solution that excludes ‘bubble’ or ‘bootstrap’ effects — one that occur only because they are arbitrarily expected to occur. A systematic procedure for obtaining solutions free from such effects is introduced and discussed. In addition, this procedure is used to interpret and reconsider several prominent examples with solution multiplicities, including ones developed by Fischer Black and John B. Taylor.     

Non-informative rational expectations equilibria when assets are nominal: An example

When assets are nominal, non-informative rational expectations equilibria exist.     

The effect of excessively elastic expectations on exchange-rate volatility in the Dornbusch overshooting model

Bilson has described the empirical finding that the forward exchange rate overestimates the speed of return to equilibrium as a finding of ‘excessive speculation’, and has drawn implications for the volatility of the exchange rate. The present paper pursues this tack within the sticky-price monetary model made famous by Dornbusch. It is shown theoretically that if the market overestimates the speed of adjustment, the degree of overshooting is reduced. In this sense ‘excessive speculation’ leads to reduced volatility.     

Stock market overreactions to bad news in good times: a rational expectations equilibrium model

This article presents a dynamic, rational expectations equilibriummodel of asset prices where the drift of fundamentals (dividends)shifts between two unobservable states at random times. I showthat in equilibrium, investors' willingness to hedge againstchanges in their own 'uncertainty' on the true state makes stockprices overreact to bad news in good times and underreact togood news in bad times. I then show that this model is betterable than conventional models with no regime shifts to explainfeatures of stock returns, including volatility clustering,'leverage effects,' excess volatility, and time-varying expectedreturns.     

Optimal expectations and the extreme information assumptions of ‘rational expectations’ macromodels

‘One might reply that the rationality of a person's choice does not depend upon how much he knows, but only upon how well he reasons from whatever information he has, however incomplete. Our decision is perfectly rational provided that we face up to our circumstances and do the best we can.’ (John Rawls, A Theory of Justice)     

Rational expectations and the expectations model of the term structure: A test using weekly data

This paper tests the joint hypothesis of rational expectations model of the term structure for three- and six-month Treasury bills. Previous studies are extended in two main directions. First, the joint hypothesis is tested using weekly data for Treasury bills maturing in exactly 13 and 26 weeks beginning in 1970 and ending in 1979. In contrast, previous studies using comparable data have typically discarded 12/13 of the sample to a form a nonoverlapping data set. Second, a more complete set of possible determinants of time-varying premiums is tested.     

The threshold effect in expected volatility: a model based on asymmetric information

This article develops theoretical insight into the thresholdeffect in expected volatility, which means that large shocksare less persistent in volatility than small shocks. The modeluses the Kyle-Admati-Pfleiderer setup with liquidity traders,informed traders, and a market maker. Information is modeledas a GARCH process. It is shown that the GARCH process for informationis transformed into a TARCH process (for 'threshold GARCH')for the market price changes. Working with information flowsallows one to derive implications for trading volume and marketliquidity which provide the basis for a more complete test ofthe model.     

An alternate method of estimating the Cagan money demand function in hyperinflation under rational expectations

An alternate method of estimating the Cagan money demand function under rational expectations is presented. The technique utilizes the side assumptions that (1) accurate contemporaneous information on the price level and money stock is available to individuals and (2) unobservable noise in the portfolio balance schedule is neglible. The procedure has three main virtues. First, it is implemented without imposing restrictions on the money supply process. Second, the procedure is extremely simple and economical. Third, it admits a simple test of a restriction implied by the Cagan money demand function. Results are related to issues in recent hyperinflation studies.     

Inventories,rational expectations,and the business cycle

The simplest macroeconomic models in which markets clear instantaneously, and expectations are rational preclude the existence of ‘business cycles’, that is, of serially correlated deviations of output from trend. This paper studies one of several mechanisms that can be used to make these so-called ‘new-classical’ models produce business cycles; the mechanism is the gradual adjustment of inventory stocks. Two macroeconomic models of inventory holdings are formulated. Both imply, first, that current output should be a decreasing function of the stock of inventories and, second, that inventories, once perturbed from equilibrium levels, should adjust only gradually. These two features are then embedded into an otherwise standard macroeconomic model in which markets clear instantaneously and expectations are rational. Two principal conclusions are reached. First, disturbances such as unanticipated changes in money will set in motion serially correlated deviations of output from trend. Second, if desired inventories are sensitive to the real interest rate, then even fully anticipated changes in money can affect real variables.