Improving Macroeconomic Model Credibility: Reducing Reliance on Frictions through Observed Inflation Expectations (Data and Scripts)

Results show that incorporating observed inflation expectations improves model fit, reduces posterior uncertainty around shocks, and lowers reliance on ad hoc rigidities such as indexation and investment adjustment costs, particularly in case of U.S. data. However, these expectations do not consistently improve the model's ability to replicate key macroeconomic moments. The magnitude and direction of improvements vary across model variants and between the U.S. and the Euro area.

Robustness checks suggest that observed expectations help mitigate the effects of structural breaks. Overall, the findings enhance model predictions and challenge the sufficiency of relying solely on rational expectations in DSGE models.