Rethinking Expectations: The Way Forward for Macroeconomics

Rethinking Expectations: The Way Forward for Macroeconomics

Rethinking Expectations: The Way Forward for Macroeconomics

Rethinking Expectations: The Way Forward for Macroeconomics


This book originated from a 2010 conference marking the fortieth anniversary of the publication of the landmark "Phelps volume," Microeconomic Foundations of Employment and Inflation Theory, a book that is often credited with pioneering the currently dominant approach to macroeconomic analysis. However, in their provocative introductory essay, Roman Frydman and Edmund Phelps argue that the vast majority of macroeconomic and finance models developed over the last four decades derailed, rather than built on, the Phelps volume's "microfoundations" approach. Whereas the contributors to the 1970 volume recognized the fundamental importance of according market participants' expectations an autonomous role, contemporary models rely on the rational expectations hypothesis (REH), which rules out such a role by design.

The financial crisis that began in 2007, preceded by a spectacular boom and bust in asset prices that REH models implied could never happen, has spurred a quest for fresh approaches to macroeconomic analysis. While the alternatives to REH presented in Rethinking Expectations differ from the approach taken in the original Phelps volume, they are notable for returning to its major theme: understanding aggregate outcomes requires according expectations an autonomous role. In the introductory essay, Frydman and Phelps interpret the various efforts to reconstruct the field--some of which promise to chart its direction for decades to come.

The contributors include Philippe Aghion, Sheila Dow, George W. Evans, Roger E. A. Farmer, Roman Frydman, Michael D. Goldberg, Roger Guesnerie, Seppo Honkapohja, Katarina Juselius, Enisse Kharroubi, Blake LeBaron, Edmund S. Phelps, John B. Taylor, Michael Woodford, and Gylfi Zoega.


Roger Guesnerie

The stability of market economies has been a recurrent subject of debate since the beginning of the nineteenth century, which is usually viewed as the starting point of economics as a scientific field. “L’offre crée sa propre demande” (“supply creates its own demand”): this formula, a remarkable digest of the argument, is supposed to capture the essence of Jean Baptiste Say’s analysis (1803). It expressed the basis for some of the early protagonists’ strong confidence in the systemic stability of markets. But others strongly disagreed: Jean Baptiste Sismondi and the “catastrophist school”— and its most famous adept, Karl Marx—awaited the next crisis (possibly the final crisis) of the capitalist system. In the middle, Léon Walras thought that Say’s argument was unconvincing but developed an alternative analysis that has long been viewed as supporting the optimists. The skepticism about market economies’ systemic stability reappeared after the 1929 crisis, and Keynes forcefully argued for government intervention to counter markets’ instability.

This chapter develops ideas that have been presented on several occasions, including at
the “Conférence Jean Jacques Laffont” of the 2010 Congress of the Association Française
de Science Economique (published in 2011 as “Défaillances de coordination et volatilité des
marchés” in La Revue Economique 62: 395–408) and at invited lectures (e.g., in the series
“Food for Thought: On a Post Mortem of the Financial Crisis” of the European Investment
Bank and at the Columbia University conference “Micro-Foundations for Macroeconomics”).
Related ideas have been presented and discussed in many seminars and workshops in Marseille,
Stanford, New Delhi, Bombay, Aix-en-Provence, and Warwick. I thank participants for their
comments and suggestions and in particular thank Ken Binmore, Massimo Cingolani, and
Partha Sen. I am especially grateful to Alan Kirman for his careful critical reading of a previous
version, which contributed to improving both the English and the content. I remain responsible
for any shortcomings.

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