Learning in a Medium-Scale DSGE Model with Expectations Based on Small Forecasting Models

Sergey Slobodyan, Raf Wouters
2012 American Economic Journal: Macroeconomics  
This paper evaluates the empirical performance of a medium-scale DSGE model (Smets and Wouters 2007) when agents form expectations about forward variables by using small forecasting models. Agents learn about these simple forecasting models through Kalman lter updating. A model with this type of adaptive learning ts the data better than the rational expectations model. Agents' beliefs about the persistence of in ation explain the observed decline in both the mean and the volatility of in ation
more » ... tility of in ation as well as the attening of the Phillips curve. Learning about in ation dynamics also results in lower estimates for the persistence of the exogenous processes that drive price and wage dynamics in the rational expectation version of the model. We also nd that expectations based on small forecasting models are closely related to the survey evidence on in ation expectations. (JEL: C11, C52, D84, E30) Slobodyan: CERGE-EI, Politickych veznu 7, 111 21 Prague 1, Czech Republic
doi:10.1257/mac.4.2.65 fatcat:fodk4lay3jbh5arkzt27xfqltm