On the Identification of Diagnostic Expectations: Econometric Insights from DSGE Models
This paper shows that diagnostic expectations (DE) and rational expectations (RE) are not observationally equivalent in dynamic stochastic general equilibrium (DSGE) models. Using the frequency-domain framework of Qu and Tkachenko (2012, 2017), I show that no RE parameterization yields the DE-implied autocovariance structure of the macroeconomic observables considered in either small- or medium-scale DSGE models, even after structural frictions and shock processes are reparameterized. Incorporating DE preserves overall identification but weakens the identification of shock variances. In the medium-scale model, among the frictions, wage rigidity emerges as most important for generating the benchmark DE model dynamics.
econ.EM↗