Expectation Response Functions in Dynamic Linear Economies

Macroeconomic disturbances affect both current fundamentals and expectations of future fundamentals, but most analyses report only the total of these effects. The expectation response function (ERF) isolates the role of expected future fundamentals in a theory. Defined as the response today to a change in expected fundamentals at each future horizon, the ERF does not depend on the fundamentals' laws of motion, the information held by agents, or the assumption of rational expectations. In applications, we show that (i) the new-Keynesian model implies modest expectational effects of technology and monetary shocks, while (ii) markup shocks in a medium-scale DSGE model have far larger expectational impacts than the “puzzling” effects of forward guidance.