Estimating Models with Rational Expectations

The assumptions needed to estimate models in which expectations of future variables are formed rationally are examined. Beginning with Lucas (1976), criticism of traditional econometric techniques based on aggregate behavioral relationships has been focused on whether the traditional estimates of macroeconomic behavioral relationships are structural. Researchers must be concerned with structural instability both in performing policy simulations and in estimating economic relationships. The common model for estimating future expectations is described. A proposed alternative shifts emphasis away from past values of labor and market conditions. Data are developed for the procedure from judgmental forecasts and commercial forecasts. As policy regulations change, so do forecasting variables. Although the procedure is not 100% accurate, it represents a substantial step forward in forecasting over previous procedures using rational expectations.