Forward Looking Price Setting in UK Manufacturing.

Given an equilibrium pricing rule, minimization of a multiperiod quadratic cost function yields a precise specification for the weights on the leads and lags of a dynamic pricing equation. Using an equilibrium (cointegrating) vector, the theoretical specification is found to fit the U.K. manufacturing data remarkably well. Non-nested tests fail to reject either the (backward looking) error correction or the forward looking model against the alternative (so long as dynamic homogeneity is imposed in the error correction model). This is consistent with the notion that the error correction model is conflating the true structural model (which is forward looking) with the expectation formation process. Copyright 1992 by Royal Economic Society.