Unfulfilled Expectations: One Economist’s History

The problem of expectations in economic models is reviewed through the intellectual development of the author. Initial efforts at macroeconomic modeling such as Foley–Sidrauski (Foley and Sidrauski 1971) treated expectations as conditioning variables for representative agent stock demands and supplies of financial and real assets. Perfect foresight (rational expectations) in this context leads to saddle-point instability of equilibrium, and the unanswered question of what behavioral forces will guarantee that the economy stays on the stable manifold. In later work such as Foley–Albin (Albin 1998), the economy appears as a complex, adaptive system far from equilibrium in which endogenous regime shifts make the statistical formation of expectations impossible. This perspective calls into question the presumed central role of expectations formation in structuring macroeconomic dynamics. The quantal response statistical equilibrium model can throw some light on the process by which markets penalize incorrect expectations of price change.