The (Un)Importance of Forward-Looking Behavior in Price Specifications

Abstract

The seminal work of Phelps, Taylor, and Cairo developed forwardlooking models of price determination that imparted inertia to the price leveh These models incorporate expectations of future prices and excess demand by imposing constraints (typically lag-lead symmetry constrainls) that force future variables to enter the specification. In this paper, I test the empirical significance of future prices-in specifications like those of Taylor. I find that expectations of future prices are empirically unimportant in explaining price and inflation behavior. However, the dynamics of a model_that includes a purely backwardlooking inflation specification differ' significantly-and not altogether pleasingly-from those with a forward-looking specification.

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