Mis-specified Forecasts and Myopia in an Estimated New Keynesian Model

Ina Hajdini

No 22-03R, Working Papers from Federal Reserve Bank of Cleveland

Abstract: The paper considers a New Keynesian framework in which agents form expectations based on a combination of autoregressive mis-specified forecasts and myopia. The proposed expectations formation process is shown to be consistent with all three empirical facts on consensus inflation forecasts. However, while mis-specified forecasts can be both sufficient and necessary to match all three facts, myopia alone is neither. The paper then derives the general equilibrium solution consistent with the proposed expectations formation process and estimates the model with likelihood-based Bayesian methods, yielding three novel results: (i) macroeconomic data strongly prefer a combination of autoregressive mis-specified forecasting rules - of the VAR(1) or AR(1) type - and myopia over other alternatives; (ii) no strong evidence is found in favor of VAR(1) forecasts over simple AR(1) rules; and (iii) frictions such as habit in consumption, which are typically necessary for models with full-information rational expectations, are significantly less important, because the proposed expectations generate substantial internal persistence and amplification to exogenous shocks. Simulated inflation expectations data from the estimated general equilibrium model reflect the three empirical facts on forecasting data.

Keywords: Myopia; Survey of Professional Forecasters (SPF); Bayesian Estimation; Internal Propagation (search for similar items in EconPapers)
JEL-codes: C11 C53 D84 E13 E30 E50 E52 E70 (search for similar items in EconPapers)
Pages: 75
Date: 2022-02-16, Revised 2023-03-06
New Economics Papers: this item is included in nep-dge, nep-for, nep-mac, nep-mon and nep-ore
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DOI: 10.26509/frbc-wp-202203r

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