Near-Rationality and Inflation in Two Monetary Regimes / Laurence Ball.

By:

Ball, Laurence

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w7988.Publication details: Cambridge, Mass. National Bureau of Economic Research 2000.Description: 1 online resource: illustrations (black and white)Subject(s):

E31 - Price Level • Inflation • Deflation

Online resources:

Available additional physical forms:

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Abstract: Sticky-price models with rational expectations fail to capture the inertia in U.S. inflation. Models with backward-looking expectations capture current inflation behavior, but are unlikely to fit other monetary regimes. This paper seeks to overcome these problems with a near-rational model of expectations. In the model, agents make univariate forecasts of inflation: they use information on past inflation optimally, but they ignore other variables. The paper tests sticky-price models with near-rational expectations for two periods in U.S. history, the post-1960 period of persistent inflation and the period from 1879 to 1914, when inflation was not persistent. The models fit the data for both periods; in contrast, both rational-expectations and backward-looking models fail for at least one period.

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October 2000.

Sticky-price models with rational expectations fail to capture the inertia in U.S. inflation. Models with backward-looking expectations capture current inflation behavior, but are unlikely to fit other monetary regimes. This paper seeks to overcome these problems with a near-rational model of expectations. In the model, agents make univariate forecasts of inflation: they use information on past inflation optimally, but they ignore other variables. The paper tests sticky-price models with near-rational expectations for two periods in U.S. history, the post-1960 period of persistent inflation and the period from 1879 to 1914, when inflation was not persistent. The models fit the data for both periods; in contrast, both rational-expectations and backward-looking models fail for at least one period.