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On Activist Monetary Policy With Rational Expectations

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  • Stanley Fischer
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    Abstract

    The paper examines the case for activist monetary policy. It accepts the view that expectations are formed rationally, but not the implication of flexible price, equilibrium, rational expectations models, that monetary policy cannot and should not be used to affect real magnitudes. The paper starts by asking why the economy has not insulated itself from monetary disturbances through the adoption of indexing and other provisions that would effectively shorten contracts, and suggests that the costs of doing so must be substantial. These costs provide the rational for activist policy, whose aim should be to adjust for aggregate disturbances that the private sector has not made provision to handle. The arguments about activist policy then become those familiar from earlier discussions by Milton Friedman, concerning the long and variable lags with which policy operates, and the alleged propensity of the Fed to misbehave. It is argued that an activist policy that does not respond to minor disturbances, but does respond to actual and prospective major disturbances, would provide a stabilizing force for the economy.

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    File URL: http://www.nber.org/papers/w0341.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0341.

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    Date of creation: Apr 1979
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    Publication status: published as Fischer, Stanley. "On Activist Monetary Policy with Rational Expectations." Rational Expectations and Economic Policy, edited by Stanley Fischer, pp. 211-248. Chicago: University of Chicago Press, 1980.
    Handle: RePEc:nbr:nberwo:0341

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    1. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    2. Martin Feldstein & Lawrence H. Summers, 1979. "Inflation, Tax Rules, and the Long Term Interest Rates," NBER Working Papers 0232, National Bureau of Economic Research, Inc.
    3. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
    4. William Poole, 1976. "Rational Expectations in the Macro Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 463-514.
    5. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
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