After a forecast failure, a respecification is usually necessary to account for the data ex post, in which case there is a gain in knowledge as a result of the forecast failure. Using Norwegian consumption as an example, we show that the financial deregulation in the mid 1980s led to forecast failure both for consumption functions and Euler equations. This constellation of forecast failures is shown to be inconsistent with an underlying Euler equation, a result that also explains why progress took the form of a respecified consumption function where wealth plays a central role. That model is updated and is shown to have constant parameters despite huge changes in the income to wealth ratio over nine years of new data.
Consumption functions equilibrium correction models Euler equations, financial deregulation forecast failure progressive research strategies VAR models