Working Paper

Vector rational error correction

Abstract: Systems of forward-looking linear decision rules can be formulated as vector \"rational\" error correction models. The closed-form solution of the restricted error corrections is derived, and a full-information estimator is suggested. The error correction format indicates that the assumptions of convex adjustment costs and rational expectations impose different types of a priori restrictions on the dynamic structure of the error corrections. An empirical model of the producer decision rule for capital investment illustrates that the data rejects dynamic restrictions imposed by a standard model of adjustment costs but supports a more general description of convex frictions.

Keywords: Vector autoregression; Rational expectations (Economic theory);

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 1998

Number: 98-03