Working Paper: NBER ID: w1044
Authors: John B. Taylor
Abstract: This paper reviews and contrasts different views about the role of expectations in policy research and practice. Recently, two widely different views seem to have dominated the analysis of policy questions.One view, which is referred to as the "new classical macroeconomic"view, is that expectations overwhelm the influence of monetary policy.The other view, which is referred to as the "Keynesian" macroeconomic view, is that expectations are unimportant because people do not adjust to expectations of policy change. The paper argues that both these views are misleading. It advances a new view of the role of expectations that is still emerging from current macroeconomic reearch. The new view recognizes the importance of contractual arrangements which prevent a modern economy from adjusting instantaneously to policy changes, even if they are expected. But it also emphasizes that forward-looking expectations influence how these arrangements are set up and how they evolve over time. Recent criticisms of this new view are reviewed, and examples are given to illustrate how quantitative methods that incorporate this view can be used in practice.
Keywords: Monetary policy; Expectations; Disinflation; Macroeconomics
JEL Codes: E52; E31; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expectations (D84) | Effectiveness of monetary policy (E52) |
| Rational expectations (D84) | Outcomes in disinflation efforts (E31) |
| Forward-looking expectations (D84) | Contractual arrangements (L14) |
| Contractual arrangements (L14) | Wage and price adjustments (E64) |
| Speed of monetary policy changes (E52) | Economic stability (E60) |
| Expectations (D84) | Adjustment process in response to policy changes (J68) |
| Expectations (D84) | Employment (J68) |
| Expectations (D84) | Inflation rates (E31) |