The London Business School econometric model of the UK

Adaptive Dual Control Methods

Does Time-Inconsistency Really Matter?

The developments in the treatment of expectations in empirical macroeconomic models that have taken place over the last 30 years are surveyed. The main concern is to focus on the implications of expectation effects in the practical use of models, i.e. in forecasting and policy analysis, rather than to consider either the theoretical literature or the literature on econometric estimation and identification, both of which are already well surveyed. The general development in expectations models is discussed first. Then the literature on linear models is considered and the development of expectations effects to large nonlinear econometric models is examined.

Expectations, learning and empirical macroeconomic models

Over the last decade, as a number of industrialised countries1 have gone over to the use of explicit inflation targets, there has been a resurgence of interest in the use of feedback rules to characterise monetary policy. In this paper we consider how the type of rule suggested by the methods of optimal control can be derived when the model we have of an economy is non-linear and the model contains forward-looking expectations. Although the literature in this area is voluminous, there is still considerable interest in seeking computational improvements to existing algorithms2 and in deriving methods that can be applied to the highly non-linear, and analytically intractable, dynamic, stochastic general equilibrium models that have grown out of the original real business cycle methodology. Although the methods we describe in this paper could be applied to this class of model, we confine our attention here to non-linear models more in the Cowles Foundation tradition.3 One approach to the problem of dealing with non-linear, rational expectations models is to apply direct methods such as the Penalty Function method of Holly and Zarrop (1983), or the extended path methods associated with Anderson, Fair and Taylor used for solution and estimation, or for computing time consistent solutions (see Hall, 1986). The disadvantage of this approach, in the context of this paper, is that the solutions are in open-loop form; there is no explicit control rule that can be compared directly to other forms of rule existing in the literature.

Instrument Rules, Inflation Forecast Rules and Optimal Control Rules When Expectations are Rational

This paper examines the role of an optimal stabilisation policy for output, prices and the exchange rate in an open economy. The market in foreign exchange is assumed to be efficient and forward-looking in the sense of the rational expectations hypothesis, but the domestic goods and labour markets are assumed to respond sluggishly. As was originally stressed by Dornbusch (1976), if in these circumstances a government attempts to reduce the rate of inflation by monetary contraction then the real exchange rate appreciates causing a loss of international competitiveness. Only as the domestic price level adjusts slowly towards its lower equilibrium will the real exchange rate move back towards its previous level.

Optimal Feedback and Feedforward Stabilisation of Exchange Rates, Money, Prices and Output Under Rational Expectations

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Optimal Feedback and Feedforward Stabilisation of Exchange Rates, Money, Prices and Output Under Rational Expectations