Expectation Formation and the Persistence of Shocks

Constantin Bürgi

No 2020-005, Working Papers from The George Washington University, Department of Economics, H. O. Stekler Research Program on Forecasting

Abstract: Persistence of economic shocks is commonly treated as deviations from rational expectations attributed to frictions like information rigidity or noisy information. This paper shows that there is persistence even without these information frictions. In the presence of uncertainty about the future, optimal forecasts place a positive weight on past predictions about the same event. The overall weight on the past prediction varies markedly over time and has an inverse relationship with the magnitude of shocks as the larger revisions after large shocks reduce the weight. Empirical estimates show that agents put a significant weight on previous prediction of inflation and output and a substantial part of the weight and hence persistence cannot be attributed to information frictions.

Keywords: Uncertainty; Information Rigidity; Information; Rational Expectations; Full Information (search for similar items in EconPapers)
JEL-codes: C53 D80 E37 E66 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2020-08, Revised 2020-09
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:gwc:wpaper:2020-005

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