Working Paper

Rational error correction

Abstract: Under general conditions, linear decision rules of agents with rational expectations are equivalent to restricted error corrections. However, empirical rejections of rational expectation restrictions are the rule, rather than the exception, in macroeconomics. Rejections often are conditioned on the assumption that agents aim to smooth only the levels of actions or are subject to geometric random delays. Generalizations of dynamic frictions on agent activities are suggested that yield closed-form, higher-order decision rules with improved statistical fits and infrequent rejections of rational expectations restrictions. Properties of these generalized \"rational\" error corrections are illustrated for producer pricing in manufacturing industries.

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1998

Number: 1998-37