Abstract

Implications of the “Rational Expectations” Hypothesis with Respect to Business Cycle Theory

The development of the theory of temporary equilibrium has taken a special direction during the recent decade. Nowadays, expectations are interpreted in the same way as decisions to result from rational economic evaluation of information. In the extreme case the market participants have all the relevant infomation. Then global macroeconomic policy has no significant systematic impact on employment given certain patterns of behaviour. This demonstration by Lucas, Sargent, et al. has attracted great attention. There are, however, alternative and equally plausible patterns of behaviour. They imply that macroeconomic policy is relevant to the explanation and, therefore, to the control of economic development. The renaissance of business cycle theory is an important by-product of this discussion about a wellinformed rational formation of expectations. The reason is this: if the market participants were well-informed they would make decisions such as to avoid losses during recessions; in other words, their dispositions would eliminate the business cycle. Given the fact that pronounced business cycles have not disappeared, we either have to abolish the hypothesis of well-informed rational expectations or to accept the supplementary hypothesis that the cycles result from externally caused and, therefore, unpredictable shocks to the system. The first case excludes the “new classical” argument about economic policy mentioned above and consequently is not maintained by the dominating modern neoclassical theory. The second case, however, leads to a conceptional problem too: the more pronounced the cycles are the larger would have to be the causing shocks as well asthe market participants’ distrustin their capabilities of forecasting due to bad experience. In sum, the shock-hypothesis also leads to scepticism with respect to the assertion that the theory and policy of business cycles has to be based on the assumption of well-informed rational expectations