Detection of anticipated structural changes in a rational expectations environment

When agents have rational expectations, anticipated changes in the structure of the economy have an immediate affect on their behaviour. In this article, we investigate the interplay between a linear rational expectation model with predictable structural changes and reduced-form evidence of structural breaks. In our study, we vary the length of time between the announcement and the implementation of an inflation target change. Using a model similar to Ireland (2007) and the method presented in Bai and Perron (1998) and Bai and Perron (2003) to estimate unknown structural breaks, Monte Carlo simulation results suggest that reduced-form evidence of structural breaks are broadly in line with what is predicted by forward-looking rational expectation models; that is, as the transition period increases, break estimates gradually move farther from the policy announcement date.