Two-Step Two-Stage Least Squares Estimation in Models with Rational Expectations

Abstract

This paper introduces a limited-information two-step estimator for models with rational expectations and serially correlated disturbances. The estimator greatly extends the area of applicability of McCallum's (1976) instrumental variables approach to rational expectations models. Section I reviews McCallum's method and discusses in detail the problems surrounding its use in many empirical contexts. Section II presents the two-step two-stage least squares estimator (2S2S1) and demonstrates its efficiency relative to that of McCallum (1979). Section III provides a comparison nf several estimators for a two equation macroeconomic model with rational expectations due to Taylor (1979).

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