Learning to Forecast and Cyclical Behavior of Output And Inflation

European University Institute Working Paper No. ECO 2000/25, University of Frankfurt Mimeo, CFS Working Paper No. 2003/02

46 Pages Posted: 2 Oct 2001

See all articles by Klaus Adam

Klaus Adam

University of Mannheim; European Central Bank (ECB) - Department of Research; Centre for Economic Policy Research (CEPR)

Date Written: November 2002

Abstract

This paper considers a sticky price model with a cash-in-advance constraint where agents forecast inflation rates with the help of econometric models. Agents use least squares learning to estimate two competing models of which one is consistent with rational expectations once learning is complete. When past performance governs the choice of forecast model, agents may prefer to use the inconsistent forecast model, which generates an equilibrium where forecasts are inefficient. While average output and inflation result the same as under rational expectations, higher moments differ substantially: output and inflation show persistence, inflation responds sluggishly to nominal disturbances, and the dynamic correlations of output and inflation match U.S. data surprisingly well

Keywords: Learning, Business Cycles, Rational Expectations, Inefficient Forecasts, Output and Inflation Persistence

JEL Classification: E32, E33, E37, D83

Suggested Citation

Adam, Klaus, Learning to Forecast and Cyclical Behavior of Output And Inflation (November 2002). European University Institute Working Paper No. ECO 2000/25, University of Frankfurt Mimeo, CFS Working Paper No. 2003/02, Available at SSRN: https://ssrn.com/abstract=285472 or http://dx.doi.org/10.2139/ssrn.285472

Klaus Adam (Contact Author)

University of Mannheim ( email )

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