Near-Rationality and Inflation in Two Monetary Regimes

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Sticky-price models with rational expectations fail to capture the inertia in U.S. inflation. Models with backward-looking expectations capture current inflation behavior, but are unlikely to fit other monetary regimes. This paper seeks to overcome these problems with a near-rational model of expectations. In the model, agents make univariate forecasts of inflation: they use information on past inflation optimally, but they ignore other variables. The paper tests sticky-price models with near-rational expectations for two periods in U.S. history, the post-1960 period of persistent inflation and the period from 1879 to 1914, when inflation was not persistent. The models fit the data for both periods; in contrast, both rational-expectations and backward-looking models fail for at least one period.

Published: Laurence Ball, 2000. "Near-rationality and inflation in two monetary regimes," Proceedings, Federal Reserve Bank of San Francisco.

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