Abstract

Ineffectiveness of Economic Policy under “Rational Expectations”?

An incorrect but also model-specific assertion The “rational expectation hypotheses”, macroeconomic theories based on the rational expectation theory conceived by John F. Muth, have become enormously popular in the past decade, beginning with the studies by Lucas, Sargent and Wallace. The conclusion drawn from them regarding the ineffectiveness of economic policy - economic policy intervention, especially money supply policy, has no effects on real goods production, but results solely in an increase in price level as long as economic policy action isrationally anticipated and isnot taken abruptly-is certainly attractive from the viewpoint of liberal economic policy, but where rational expectation hypotheses are applied it is backed up only by model-specific arguments and is therefore contestable. Furthermore, the argumentation of the “rationalists” contains the economic-policy possibility of an apparently risk-free containment of inflation. With the basic model of the rational expectation hypotheses it can be demonstrated that any form of economic policy intervention - whether procyclic or anticyclic, whether monetary or fiscal - is condemned to ineffectiveness with regard to real effects by the very make-up of the model. In the opposite direction, the logic of the basic model incorporates the possibility of fixing the price level almost at will by economic policy action without having to accept any real impact on goods production. In conclusion, it can be shown that these model-specific results are due mainly to the peculiarities of the Lucas supply function. A simplified, but perfectly plausible modification of the supply function results in real effects of economic policy, even if the not uncontroversial concept of rational expectations is retained, so that in the final analysis the thesis of ineffectiveness is reduced to a special assumption.