Working Paper: NBER ID: w19368
Authors: Michael Woodford
Abstract: This paper reviews a variety of alternative approaches to the specification of the expectations of economic decisionmakers in dynamic models, and reconsiders familiar results in the theory of monetary and fiscal policy when one allows for departures from the hypothesis of rational expectations. The various approaches are all illustrated in the context of a common model, a log-linearized New Keynesian model in which both households and firms solve infinite-horizon decision problems; under the hypothesis of rational expectations, the model reduces to the standard "3-equation model" used in studies such as Clarida et al. (1999). The alternative approaches considered include rationalizable equilibrium dynamics (Guesnerie, 2008); restricted perceptions equilibria (Branch, 2004); decreasing-gain and constant-gain variants of least-squares learning dynamics (Evans and Honkapohja, 2001); rational belief equilibria (Kurz, 2012); and near-rational expectations equilibria (Woodford, 2010). Issues treated include Ricardian equivalence; the determinacy of equilibrium under alternative interest-rate rules; non-fundamental sources of aggregate instability; the trade-off between inflation stabilization and output-gap stabilization; and the possibility of a "deflation trap."
Keywords: No keywords provided
JEL Codes: E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| non-rational expectations (D84) | different conclusions about monetary and fiscal policies (E62) |
| rational expectations (D84) | standard three-equation model (C20) |
| alternative expectations approaches (D84) | distinct dynamics in aggregate demand and supply (E00) |
| rationalizable equilibrium dynamics (C73) | instances of aggregate instability (C62) |
| how expectations are formed (D84) | trade-off between inflation stabilization and output gap stabilization (E63) |
| certain specifications of expectations (D84) | deflation trap (E31) |