Working Paper: CEPR ID: DP7078
Authors: Andrew Hughes Hallett; Giovanni Di Bartolomeo; Nicola Acocella
Abstract: Rational expectations are often used as a strong argument against policy activism, as they may undermine or neutralize the policymaker?s actions. Although this sometimes happens, rational expectations do not always imply policy invariance or ineffectiveness. In fact, in certain circumstances rational expectations can enhance our power to control an economy over time. In those cases, policy announcements, properly communicated, can be used to extend the impact of conventional policy instruments. In this paper we present a general forward-looking policy framework and use it to provide a formal justification for attempting to anchor expectations, and as a possible justification for publishing interest rate forecasts or tax rate projections. This approach allows us to test when policymakers can and cannot expect to be able to manage expectations.
Keywords: Controllability; Fiscal Policy; Monetary Policy; Policy Neutrality; Rational Expectations
JEL Codes: C61; C62; E52; E61; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Rational expectations (D84) | Policy control (E64) |
| Effective communication (L96) | Rational expectations (D84) |
| Policy announcements (E60) | Expectations (D84) |
| Expectations (D84) | Economic outcomes (F69) |
| Policy announcements (E60) | Economic policy effectiveness (F68) |
| Effective communication (L96) | Dynamic controllability (C61) |
| Policy announcements + Conventional policy instruments (E61) | Extended impact (F69) |
| Credible communication (D83) | Private sector expectations adjustment (E69) |