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Vector Rational Error CorrectionSharon Kozicki |
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. Sharon Kozicki is a senior economist at the Federal Reserve Bank of
Kansas City. P.A. Tinsley is Deputy Associate Director, Division of Research and
Statistics, at the Board of Governors of the Federal Reserve System. The views xpressed in
this paper are those of the authors and do not necessarily represent those of the Board of
Governors or staff of the Federal Reserve System.
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