Ray C. Fair

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Discussion Paper

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A more sophisticated expectational hypothesis than is traditionally used in the specification of macroeconometric models is tested in this paper. Economic agents are assumed to use a vector of variables Z t in forming their expectations for periods t + 1 and beyond. These expectations may or may not be rational in the Muth sense. The results provide some evidence in favor of the more sophisticated hypothesis, but they are not strong enough to allow much weight to be put on the hypothesis as yet. The evidence in favor of the hypothesis is strongest for households’ response to future wages and prices in their consumption and labor supply decisions and for the Fed’s response to future inflation rates. The sensitivity of the policy properties of my macroeconometric model to the more sophisticated hypothesis is also examined in the paper. The properties are not sensitive for a policy action in which government expenditures are changed. They are somewhat sensitive for an action in which personal tax rates are changed. In the latter case the properties are also sensitive to whether or not the policy action is anticipated.

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