Abstract: We develop a set of necessary and sufficient conditions for equilibria to be determinate in a class of forward-looking Markov-switching rational expectations
models, and we develop an algorithm to check these conditions in practice.
Sargent and Wallace (1975) used the idea of rational expectations
in an otherwise standard IS-LM macromodel with an expectations-augmented Phillips curve to argue that systematic monetary policy actions do not systematically affect unemployment or output.
However, the first analysis of inflation under the rational expectations
hypothesis--known subsequently as the "islands theory"--was not considered quite satisfactory by many economists.
TIE: Your book leads an assault against the rational expectations
school of economics.
Recently macroeconomists have moved to a new neo-classical synthesis by integrating Keynesian features like imperfect competition and nominal rigidities with dynamic stochastic general equilibrium model of the Real Business Cycle Theory with micro foundations and rational expectations
, [see, for instance, McCallum and Nelson (1999)].
I think some people feel that the Brookings Papers missed something in that two prominent developments in macroeconomics over the period of its existence--the rational expectations
revolution and the simple general-equilibrium real business cycle model--did not figure prominently in the Panel's discussions.
Proponents of rational expectations
argued that the question was irrelevant.
The Solution of Linear Difference Models under Rational Expectations
," Econometrica, 48, 5, July 1980, pp.
This was reflected in the rules versus discretion debate in monetary policy, (Kydland and Prescott 1977), in the development of rational expectations
econometrics (eg Sargent 1973, Barro 1977, McCallum 1983) and in the construction of models with forward looking agents.
Indeed it could be described as a triumph of rational expectations
in which the climate of monetary credibility fuels a self-fulfilling inflation control.
Because Campbell and Cochrane's model retains rational expectations
, whereas Cecchetti, Lam, and Mark's model is based on distorted beliefs, the two models' implications for survey forecasts will differ.
Cao, 1999, "The Effect of Derivative Assets on Information Acquisition and Price Behavior in a Rational Expectations
Equilibrium", Review of Financial Studies, 12:131-163