Working Paper: NBER ID: w0789
Authors: Frederic S. Mishkin
Abstract: A heated debate has arisen over what Modigliani has dubbed the Macro Rational Expections (MRE) hypothesis. This hypothesis embodies two component hypotheses: 1) rational expectations and 2) short-run neutrality -- i.e., that anticipated changes in aggregate demand will have already been taken into account in economic agents' behavior and will thus evoke no output or employment response. Together these component hypotheses imply that deterministic feedback policy rules will have no effect on business cycle fluctuations. The irrelevance of these types of policy rules is inconsistent with much previous macro theorizing as well as with the views of policymakers. It is thus an extremely controversial proposition which requires a wide range of empirical research. This paper is a sequel to a previous paper by the author. That paper developed a methodology for testing the MRE hypothesis and found that anticipated money growth does matter to the business cycle. This paper extends the analyses to cases where the rate of nominal GNP growth or the inflation rate, rather than money growth, is the aggregate demand variable. The empirical results are also negative on the MRE hypothesis and its corresponding policy ineffectiveness proposition.
Keywords: aggregate demand; macroeconomics; rational expectations
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| anticipated nominal GNP growth (O42) | output (C67) |
| anticipated nominal GNP growth (O42) | unemployment (J64) |
| anticipated aggregate demand policy (E00) | business cycles (E32) |
| anticipated nominal GNP growth and inflation (O42) | neutrality proposition (F11) |