Learning to Forecast and Cyclical Behavior of Output and Inflation

Posted: 19 Aug 2004

See all articles by Klaus Adam

Klaus Adam

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

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. Available at SSRN: https://ssrn.com/abstract=577686

Klaus Adam (Contact Author)

University of Mannheim ( email )

Department of Economics
L7 ,3-5
Mannheim, 68131
Germany

HOME PAGE: http://adam.vwl.uni-mannheim.de/1528.0.html

European Central Bank (ECB) - Department of Research ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6597 (Phone)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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