Empirical tests of the formation of expectations

The aim of this paper is to give an overview of empirical studies that test different hypotheses on how economic agents form their expectations of future events, such as the price level next year and demand towards firms. The survey may serve as a guide when deciding which assumptions should be made on how expectations are formed as well as help those that plan to do empirical work in the area.

In economic theory the question of how expectations are formed has long been seen as crucial to the question of how the economy works. Let us illustrate by a firm taking decisions on real investments which will increase the firm's production capacity. The decision makers have to make up their mind of how the world will look like tomorrow - and not only on how their own increased capacity will influence the total supply and hence the price in the market, but also how the rest of the economy will evolve. Conditions important to the firm's current decisions are the future demand in the market and the part of it directed towards the firm, future prices on own products and on raw materials and energy in addition to labour costs in next periods. They also have to form expectations of other firms' decisions and the government's decisions. The predictions the decision makers in the firm make, will not only influence their investments decisions, but the current and future states of the whole economy and also the effects of policies.