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

Stephen Cole and Fabio Milani

Macroeconomic Dynamics, 2019, vol. 23, issue 3, 974-1007

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.

Date: 2019
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Related works:
Working Paper: The Misspecification of Expectations in New Keynesian Models: A DSGE-VAR Approach (2016)
Working Paper: The Misspecification of Expectations in New Keynesian Models: A DSGE-VAR Approach (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:cup:macdyn:v:23:y:2019:i:03:p:974-1007_00

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