Is the Rational Expectations Hypothesis Enough?

Some thoughts on rational expectations models, and alternate formulations

Testing rational expectations in a cointegrated VAR with structural change

The rational expectations hypothesis is by far the most common expectations assumption used in macroeconomic research today. This hypothesis, which simply states that people’s expectations are the same as the forecasts of the model being used to describe those people, was first put forth and used in models of competitive product markets by John Muth in the 1960s. But it was not until the early 1970s that Robert Lucas (1972, 1976) incorporated the rational expectations assumption into macroeconomics and showed how to make it operational mathematically. The ‘rational expectations revolution’ is now as old as the Keynesian revolution was when Robert Lucas first brought rational expectations to macroeconomics.

Many macroeconomic models involving rational expectations give rise to an infinity of solution paths, even when the models are linear in all variables. Some writers have suggested that this non-uniqueness constitutes a serious weakness for the rational expectations hypothesis. One purpose of the present paper is to argue that the non-uniqueness in question is not properly attributable to the rationality hypothesis but, instead, is a general feature of dynamic models involving expectations. It is also argued that there typically exists, in a very wide class of linear rational expectations models, a single solution that excludes "bubbl&' or "bootstrap" effects--ones that occur only because they are arbitrarily expected to occur. A systematic procedure for obtaining solutions free from such effects is introduced and discussed. In addition, this procedure is used to interpret and reconsider several prominent examples with solution multiplicities, including ones developed by Fischer Black and

Indeterminate equilibrium rational expectations (RE) models are ubiquitous in both theoretical and applied work in dynamic macroeconomics. The issue of characterizing the exact dimension of indeterminacy—i.e. of deriving the full set of causal and stable solutions to linear RE models—has only recently been addressed in the context of general and multivariate settings. This paper complements existing results by identifying bounds on the observable dimension of indeterminacy of linear RE models in the presence of arbitrary initial conditions. Implications for the estimation of indeterminate equilibrium RE models are discussed.

The idea that markets might aggregate and disseminate information and also resolve conflicts is central to the literature on decentralization (Hurwicz, 1972) and rational expectations (Lucas, 1972). We report on three series of experiments all of which were predicted to have performed identically by the theory of rational expectations. In two of the three series (one in which participants trade a complete set of Arrow-Debreu securities and a second in which all participants have identical preferences), double auction trading leads to efficient aggregation of diverse information and rational expectations equilibrium. Failure of the third series to exhibit such convergence demonstrates the importance of market institutions and trading instruments in achievement of equilibrium.

This paper discusses inference for rational expectations models estimated via minimum distance methods by characterizing the probability beliefs regarding the data generating process (DGP) that are compatible with given moment conditions. The null hypothesis is taken to be rational expectations and the alternative hypothesis to be distorted beliefs. This distorted beliefs alternative is analyzed from the perspective of a hypothetical semiparametric Bayesian who believes the model and uses it to learn about the DGP. This interpretation provides a different perspective on estimates, test statistics, and confidence regions in large samples, particularly regarding the economic significance of rejections in rational expectations models.

The paper is concerned with the role of monetary policy and argues that activist monetary policy can affect the behavior of real output, rational expectations notwithstanding. A rational expectations model with overlapping labor contracts is constructed, with each labor contract being made for two periods. These contracts inject an element of short-run wage stickiness into the model. Because the money stock is changed by the monetary authority more frequently than labor contracts are renegotiated, and, given the assumed form of the labor contracts, monetary policy has the ability to affect the short-run behavior of output, though it has no effects on long-run output behavior.

Forecasts of economic variables is very important for planning and policy making purposes. Forecasts is an important input in decision making processes because obtaining reliable forecasts of some relevant macroeconomic variables is necessary for efficient management of funds, time and resources.Business has always recognised the need for a view of the future and has used explicit forecasts in the design and execution of their economic andJor business policies. For example, a firm trying to decide upon its investment programme will have to take into account not only the current known set of circumstances but also the unknown economic and business conditions in the future. The firm has to form a view about the future, such as the likely sales, costs, prices, competitors' reactions, labour requirements, government regulations and so on. These views about the future values of economic variables are frequently referred to as 'expectations', that is, what the firm expects to happen in the future.In recent years the performances of many microeconomics and macroeconomics series have been erratic. For example, rate of inflation, price of crude oil, prices of primary commodities, rate of interest and other pertinent economic variables have been fluctuating widely and have caused concern among the public, politicians, economists and also the businessmen. According to Mayes (l 981), with such non-uniformity of economic variables observed in the last two decades, the role of expectations has become more relevant in the economic agents' decision making process. Mayes (1981) further states that under the present conditions it has become more important to consider what expectations actually are and how they are formed.The value of economic forecasts of certain macroeconomic variables can be derived from several methods. The three main methods for deriving economic forecasts are (i) time series, (ii) econometric models, and (iii) survey of intentions of concerned agents and organizations. Time seriesanalysis and econometric modeling are the two most widely used methods in economic forecasting, but Holden and Peel (1983) had noted their drawbacks. Recently, economists have turned their direction of interest in evaluating the rationality of economic forecasts from surveys of market participants. The empirical literature on the direct tests of the rational expectations hypothesis is vast and growing. Holden et al. (1985), Lovell (1986), Wallis (1989), Maddala (1991) and Pesaran (1991) had reviewed some of these studies. The aim was to determine whether survey data on economic forecasts are accurate in the Muth's (1961) sense, that is, whether participating economic agents used all available information at the time forecasts are made. in other words, the rational expectations hypothesis of the economic forecast was put to test. In general, the empirical studies do not support the rational expectations hypothesis.Most of the studies carried out to evaluate the rationality of business firms' forecasts of economic variables were conducted on developed nations. Madsen (1993) studies the formation of output expectations in manufacturing industry in Japan, Denmark, Finland, France, Germany, Netherlands, Norway, Sweden and the United Kingdom. He found that the rational expectations hypothesis was weakly rejected. Williams (1988) and Chazelas (1988) found investment forecasts biased predictors of the actual investment value for firms in the United Kingdom and France. Meganck et a!. (1988) have concluded that investment forecasts of the manufacturing firm in Belgium were unbiased predictors of the actual values. However. Daub (1982) failed to find any rationality of the Canadian capital investment intention survey data. On the other hand. a study by Leonard (1982) on employment forecasts by the United States services sectors found that the forecasts were biased and the rationality of these employment forecasts rejected.The purpose of this paper is to present some empirical evidence on the rationality of agricultural firm managers' expectations using survey data. This study is important because it adds to the current literature on the testing of rationality of survey data, in particular, it provides empirical evidence from the perspective of a developing country. As for the country under study, the finding of the study could establish whether the forecasts documented by such survey are accurate or not; and if not, ways to produce more accurate forecasts must be found. 'Rationality' in this paper means that managers in agricultural firms have unbiased expectations and efficiently utilised available information at the time the forecasts are made.

Testing the restrictions implied by the rational expectations hypothesis

The article presents a comprehensive analysis of the global consequences caused by the development of light industry for achieving the Sustainable Development Goals. The ecological context allows us to focus on how light industry affects climate change, resource depletion, waste generation and water pollution. It is emphasized that the impact of light industry can create significant challenges for sustainable development related to SDG 13 (Climate action), SDG 6 (Clean water and sanitation), SDG 12 (Responsible consumption and production), SDG 14 (Life below water) and SDG 15 (Life on land). The article also examines the socio-economic context, discusses how light industry leads to persistent inequality, loss of traditional skills and cultural heritage, as well as trade imbalance. In terms of social responsibility, light industries have a history of violations of working conditions and labour rights. The socio-economic impacts considered may hinder the achievement of SDGs such as SDG 5 (Gender equality), SDG 8 (Decent work and economic growth), SDG 9 (Industry, innovation and infrastructure), SDG 10 (Reduced inequalities), SDG 11 (Sustainable cities and communities) and SDG 12 (Responsible consumption and production), SDG 17 (Partnerships for the goals). The theory of rational expectations is used to predict the development of light industry and its subsequent impact on sustainable development in the post-pandemic period. The prospects of applying the theory in the training of specialists for light industry are substantiated. The impact of the consequences of the pandemic and the war in Ukraine on the decision-making processes in light industry and their alignment with the sustainable development goals, taking into account civilizational challenges, is considered. In the process of research, an econometric model has been developed to determine the desired balance of interests between education and production based on rational expectations in a sustainable development environment. It advocates harmony between these two aspects, based on rational expectations, to promote sustainable development. This balance is crucial for achieving SDG 4 (Quality Education), SDG 9 (Industry, Innovation and Infrastructure) and SDG 17 (Partnerships for the goals). The properties of the model provide a wide range of applications, allowing to estimate the impact of a variety of factors on sustainable development in light industry. The developed model can be applied to estimate the values of the dependent variable for individual countries or regions, as well as to analyse the influence of independent and control variables on changes in its value. As a planning tool, the model can be adapted to develop context-sensitive sustainability strategies in light industries. The article offers ideas and practical solutions for using the potential of light industry in the pursuit of sustainable development in conditions of rational expectations.

The New Classical School works with rational expectations and full flexibility of prices and wages in all markets. The concept of rational expectations hypothesis (REH) was first introduced by J.F. Muth (1961). Robert E.R. Lucas Jr. (1972) developed and popularized this hypothesis. Thomas Sargent, Neil Wallace, Robert Barro are other distinguished representatives of this school. What is important in the New Classical School is first of all the assumption of full flexibility of prices and wages. As a result of this assumption, all markets will reach perfect equilibrium, economy will automatically settle at the point of full employment. Unemployment will be voluntary which will be denoted as “natural rate of unemployment”. According to REH, on the other hand, all the economic agents have full knowledge and information about economic decisions – including government policies and their effects – and take into account their future expectations in a right way. In this case, the government policies which will be expected and known to everybody will be already taken into account and the decisions on prices and quantities are formed accordingly, thus prices are formed in a complex fashion. In this manner, efficiency of government policies neutralized. Hence, as much as Keynesian financial policies, monetarist monetary policies are ineffective as well. The only effective impact in economy seems to be “unexpected shocks” and accordingly “unexpected” or “shock”. New Classical School have had weight after 70s due to inflationary effects of the Vietnam War and the stagflation following 1973-1974 oil shock. Hence the economic conservatism both during Regan era in the United States and Thatcher era in Britain effected the policy implementations for a while. However, it was not possible to prevent inflation; on the contrary, unemployment reached a new and higher dimension. Therefore, once more but this time with more cautious approach, a mix Keynesian and Monetarist policy implementation was adopted. On one hand, radical fiscal policies were implemented in order to prevent or decrease the budgetary gaps, on the other hand, monetary policies were applied for fine-tuning of economy, however this fine-tuning was not in the form of fixing money supply in the long run as recommended by the Monetarists. These policies were particularly based on the Keynesian analysis taken up in a broader perspective; that is to say, monetary policies being more effective in recession periods rather than fiscal policies.

This survey provides a detailed description of some of the recent theoretical and empirical literature on rational expectations econometrics. The survey pays special attention to non–stationarity of the data, and to the various methods for evaluating rational expectations models that have been developed as alternatives to the classical statistical approach of testing overidentifying restrictions. These methods have become very popular and widely used in empirical research. We provide an illustration using Danish stock market data, and we summarize the many results obtained recently using these measures in areas as diverse as stock prices, the term structure of interest rates, exchange rates, consumption and saving, the balance of payments, tax–smoothing, hyperinflation, and linear quadratic adjustment cost models for inventories, labour demand, and money demand.

Efficient solution techniques for dynamic non-linear rational expectations models

Techniques for achieving optimal money supply rules in a rational expectations macroeconomic model