The Rational Expectations Revolution: Readings from the Front Line
Preston J. Miller
MIT Press, 1994 - Business & Economics - 512 pages
These twenty-one collected readings describe the origins and growth of the revolutionary approach to macroeconomic analysis known as rational expectations. The readings trace the development of this approach from the late 1970s, when it was viewed by many as radical, to the present, when it has attained a central position in macroeconomic theory and policymaking.
In the 1970s the rational expectations school challenged the traditional Keynesian view of the world. Economic models built on the ideas of John Maynard Keynes treat the economy more or less as a system of controllable inanimate objects blindly following rules. Models built on the new ideas attempt to acknowledge the ability of humans to change behavior when they expect economic policies to change. The repercussions of this dramatic shift in thought are still being felt among practicing macroeconomic theorists and policymakers.
Much of the research on the rational expectations approach has been done by scholars affiliated with the Federal Reserve Bank of Minneapolis. The readings in this book were all originally published by the Fed, primarily as articles written to be understood by college-level economics students and noneconomist policymakers. Some of the articles are modern classics that are otherwise out of print. Scholars represented here include such prominent economists as Robert E. Lucas, Jr., Edward C. Prescott, Thomas J. Sargent, Michael R. Darby, Finn E. Kydland, Lawrence H. Summers, and Neil Wallace.
The book also includes introductory essays by Preston J. Miller, an economist and Vice President at the Federal Reserve Bank of Minneapolis. Miller explains the context in which the articles were originally published and guides readers through the basic disputes between the old and new macroeconomic approaches.
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Page xi - views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Introduction
Page 6 - intellectual event called the Keynesian Revolution can be salvaged and put to good use and which others must be discarded. Though it is far from clear what the outcome of this process will be, it is already evident that it will necessarily involve the reopening of basic issues in monetary economics which have been viewed since the thirties as "closed
Page 6 - and reconstruction. We begin by reviewing the econometric framework by means of which Keynesian theory evolved from disconnected, qualitative talk about economic activity into a system of equations which can be compared to
Page 355 - can calculate the motions of the heavenly bodies, but not the madness of people. —Sir Isaac Newton
Page 6 - a systematic way and which provide an operational guide in the necessarily quantitative task of formulating monetary and fiscal policy. Next, we identify those aspects of this framework which were central to its failure in the seventies. In so doing, our intent is to establish that the difficulties are
Page 26 - filter also permits the derivation of optimum decision rules for an interesting class of nonstationary exogenous processes assumed to face agents. Equilibrium theorizing in this context thus readily leads to a model of how process nonstationarity and Bayesian learning applied by agents to the exogenous variables
Page 59 - Our ability as economists to predict the responses of agents rests, in situations where expectations about the future matter, on our understanding of the stochastic environment agents believe themselves to be operating in. In practice, this limits the class of policies the consequences of which we can hope to assess in advance to policies generated by fixed, well understood, relatively permanent rules
Page 8 - parameters, it is necessary to know a great deal about them in advance. If enough prior information is imposed, it is possible to extract estimates of the Aj's, BJ'S, Rj's implied by the data in combination with the prior information. For purposes of ex ante forecasting, or the unconditional prediction of the vector
Page 9 - restrictions which amount to a priori setting of many elements of the Rj's to zero. (c) A priori classifying of variables as exogenous and endogenous. A relative abundance of exogenous variables aids identification. Existing large Keynesian macroeconometric models are open to serious challenge for the way they have introduced each type of restriction.