Working Paper: NBER ID: w1381
Authors: Herschel I. Grossman
Abstract: This paper focuses on the problem of formulating an analysis of economic policy that is consistent with rational expectations. Cooley, LeRoy,and Raymon show that the Lucas and Sargent strategy for econometric policy evaluation is itself vulnerable to the logic of the Lucas critique. The present discussion develops the distinction between counter factuals and forecasts to clarify the nature of the inconsistencies in the Lucas and Sargent strategy. The paper goes on to propose and to illustrate a strategy for positive economic analysis that incorporates choice-theoretical modelling of policy. Such modelling can allow better forecasting, but it also shifts attention away from policy actions and their effects and towards the more fundamental relation between the policymaker's constraints and targets and economic outcomes. The forecasting problem in a choice-theoretic model of policy concerns the effects of hypothetical realizations of variables that determine the policymaker's constraints and targets. The analysis of counter factuals in this context recognizes that the parameters of the policy process are not invariant with respect to the processes that generate these exogenous variables. A program of positive economics that includes choice-theoretic modelling of policy also preserves a distinct role for policy advice as part of the process being modelled.
Keywords: Economic Policy; Rational Expectations; Counterfactuals; Forecasts
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy actions (D78) | behavior of private agents (D82) |
| policy regime changes (E65) | expectations of private agents (L85) |
| expectations of private agents (L85) | economic outcomes (F61) |
| policy actions (D78) | economic outcomes (F61) |
| policy regime (E65) | expectations of private agents (L85) |
| policy regime (E65) | economic outcomes (F61) |
| rational expectations framework (D84) | forecasting accuracy (C53) |