Karel Musil, Stanislav Tvrz, Jan Vlček
The paper deals with the treatment of shocks in central banks’ forecasts. Within the rational expectations (RE) concept, which is widely used in structural macroeconomic models, the paper highlights the differences between news and surprise shocks and argues that most shocks in central bank forecasts should be treated as news. The paper also points out some drawbacks of news shocks under the assumption of full information from the practical point of view of forecasting and policy decision-making at central banks. As a potential solution, the paper refers to the LIRE concept as introduced in Brázdik et al. (2020). The paper discusses the properties of the LIRE concept and finds it versatile and useful in dealing with news shocks without abandoning the RE framework. The paper concludes that LIRE can be effectively used for practical structural macroeconomic modelling.
JEL codes: D58, D84, E37, E52
Keywords: Anticipated shocks, conditional forecast, DSGE models, rational expectations
Issued: December 2021
Download: RPN No. 2/2021 (pdf, 1.2 MB)