The Role of Stickiness, Extrapolation and Past Consensus Forecasts in Macroeconomic Expectations

Abstract

We propose a simple model of expectation formation with three distinct deviations from fully rational expectations. In particular, forecasters’ expectations are sticky, extrapolate the most recent news about the current period, and depend on the lagged consensus forecast about the period being forecast. We find that all three biases are present in the Survey of Professional Forecasters as well as in the Survey of Professional Forecasters as well as in the Livingston Survey, and that their magnitudes depend on the forecasting horizon.Moreover, in an over-identified econometric specification, we find that the restriction on coefficients implied by our model is always close to being satisfied and in most cases not rejected. We also stress the point that using the past consensus forecast to form expectations is a reasonable thing to do if a forecaster is not able to come up with fully rational expectations all by herself.