October 11, 2011

INSTEAD IT'S BEEN DISCREDITED BY THE LOOSE MONETARY POLICY EXPERIMENT:

The Return of Rational Expectations (WSJ, 10/11/11)

This year's winners of the Nobel Prize in economics have played key roles in developing what we now call modern macroeconomics. But we wouldn't blame Thomas Sargent and Christopher Sims if they feel less than fully welcome these days in the field they helped to shape.

Consider Mr. Sargent's influential work on rational-expectations models. According to this theory, people do not respond passively to changes in economic policy or circumstances. They anticipate future conditions and adjust according to their best interests.

As Mr. Sargent, who teaches at New York University and is a fellow at the Hoover Institution, has put it: "The concept of rational expectations asserts that outcomes do not differ systemically (i.e., regularly or predictably) from what people expected them to be. The concept is motivated by the same thinking that led Abraham Lincoln to assert, 'You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time.' . . . [Rational expectations] does not deny that people often make forecasting errors, but it does suggest that errors will not persistently occur on one side or the other."

This means it is hard for politicians to manipulate people into behaving in ways that don't make economic sense. One implication is that loose monetary policy cannot permanently lower unemployment because people will anticipate higher future inflation and demand higher wages and interest rates in compensation.

Sorry, our headline isn't really fair.  Instead, no one rational believes that loose money nonsense while they do believe that costs will keep falling as they have for thirty years.

Posted by at October 11, 2011 5:54 AM
  

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