Consistently wrong: Neoclassical micro-foundations and the macroeconomic policy ineffectiveness hypothesis
AbstractThe rational expectations hypothesis (REH) is based on two assumptions. The first is that, economic agents learn through experience how to avoid systematic errors. The second is that these errors are identified with reference to a model. Imperfect information may lead economic agents to misperceive changes in nominal economic variables as real but they learn from their mistake, change their behavior and will not make the same mistake again. Therefore, relations estimated from historical data may not hold after economic agents learned about the effects of, say, expansionary macroeconomic policies (the Lucas critique). Repeating the policy will affect nominal variables (prices) but not the real economy (policy ineffectiveness hypothesis). Policy ineffectiveness is derived from models based on neoclassical micro-foundations, claimed to be the basis for rigorous science. In this paper we investigate the learning process rigorously. When pulled into employment by misperceived expansionary macroeconomic policy, what do workers actually learn? Do they actually experience the long-run solution of the neoclassical model? After the introduction we discuss learning in the context of rational expectations. We then analyze the workers’ experience and the learning process, strictly applying neoclassical micro-foundations. We focus on two inconsistencies. First, unless unearned income is indexed, inflation will unambiguously cause labor supply to expand. Second, employers will respond to the macroeconomic impulse –misperceived or not-- with capacity expansion rather than pure price reactions. We conclude that the predictions of the REH do not hold if neoclassical micro foundations are rigorously applied.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Universitätsbibliothek Wuppertal, University Library in its series Schumpeter Discussion Papers with number SDP13010.
Date of creation: Dec 2013
Date of revision:
Contact details of provider:
Web page: http://elpub.bib.uni-wuppertal.de
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Blinder, Alan S. & Solow, Robert M., 1973. "Does fiscal policy matter?," Journal of Public Economics, Elsevier, vol. 2(4), pages 319-337.
- Blinder, Alan S, 1988. "The Fall and Rise of Keynesian Economics," The Economic Record, The Economic Society of Australia, vol. 64(187), pages 278-94, December.
- Friedman, Benjamin M., 1980. "Survey evidence on the `rationality' of interest rate expectations," Journal of Monetary Economics, Elsevier, vol. 6(4), pages 453-465, October.
- Benjamin M. Friedman, 1980. "Survey Evidence on The Rationality of Interest Rate Expectations," NBER Working Papers 0261, National Bureau of Economic Research, Inc.
- Ronald SCHETTKAT, 2010. "Will only an earthquake shake up economics?," International Labour Review, International Labour Organization, vol. 149(2), pages 185-207, 06.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Frank Hoffmann).
If references are entirely missing, you can add them using this form.