Price Determination and Rational Expectations

Thórarinn Pétursson

International Journal of Finance & Economics, 1998, vol. 3, issue 2, 157-67

Abstract: A forward looking specification of the error correction model is estimated for Icelandic inflation for the period 1962-93. Our results are consistent with the view that prices are set by rational, forward looking firms, reacting to expected future innovations in production costs. The forward model is statistically well determined, and the rational expectations, cross-equation restrictions are accepted. We find that the model has stable and plausible parameter values with a stable VAR expectations generating process. Non-nested tests indicate that the forward looking specification cannot be rejected against a statistically well determined backward looking specification. Copyright @ 1998 by John Wiley & Sons, Ltd. All rights reserved.

Date: 1998
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