A Macroeconomics Reader

By Brian Snowdon; Howard R. Vane | Go to book overview

12

A child’s guide to rational expectations

Rodney Maddock and Michael Carter

Journal of Economic Literature (1982) 20, March, pp. 39-51

DRAMATIS PERSONAE

(In order of speaking)

Ernie, first student, is something of a Keynesian.

Bert, second student, is more inclined to monetarism.

Scene I

Prologue

Scene II

The idea of rational expectations

Deriving the impotence results

Criticisms

Scene III

Testing

Significance

Conclusion

Appendix A

Aggregate supply

Appendix B

Algebra of the model

References

SCENE I

Prologue

(Two students sharing coffee in the union of an Australian university. )

Ernie: Did you read that ridiculous article in Challenge the other day?

Bert: Which?

Ernie: Somebody named Bennett McCallum was saying that rational expectations proved that the government could not stabilize the economy. Hang on, I’ve got it here: ‘An accurate understanding of how expectations are formed leads to the conclusion that short-run stabilization policies are untenable’ (McCallum 1980:37). I don’t know how they could develop theories like that. It’s pretty obvious that government policy does affect the economy in the short run.

Bert: He didn’t say they could not affect the economy in the short run or even in the long run. The key word is stabilize. 1 Just think about what’s happened in the last few years—record inflation and record unemployment. You don’t call that stabilization, do you?

-295-

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