Introduction

In recent years the availability of relatively long panel data on expectations obtained from surveying professional forecasters has made it possible to test the validity of different expectations formations mechanisms in a scientific manner. The use of panel data enables the econometrician to decompose forecast errors into macroeconomic aggregate shocks for which forecasters should not be held responsible, and forecast specific idiosyncratic errors and biases for which they should be held accountable. Muth (1961) suggested that theories of expectation formation should be consistent with the economic model being considered, and defined expectations to be rational if they are equal to mathematical expectations conditional on the set of all information relevant for forecasting. Since the rational expectations hypothesis (REH) has wide-ranging implications for economic theory and policy, it is not surprising that several economists have used survey data on expectations in order to test REH directly. Using the American Statistical Association – National Bureau of Economic Research (ASA-NBER) survey of professional forecasters, Zarnowitz (1985) has performed tests of rationality of forecasts of inflation and other macroeconomic variables. He found that the inflation forecasts did not satisfy rationality; even though many of the other forecasts were rational. Keane and Runkle (1990) have argued that the inability of most researchers to accept REH is due to the use of incorrect methodology.