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Counterfactuals, Forecasts, and Choice-Theoretic Modelling of Policy

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  • Herschel I. Grossman

Abstract

This paper focuses on the problem of formulating an analysis of economic policy that is consistent with rational expectations. Cooley, LeRoy,and Raymon show that the Lucas and Sargent strategy for econometric policy evaluation is itself vulnerable to the logic of the Lucas critique. The present discussion develops the distinction between counter factuals and forecasts to clarify the nature of the inconsistencies in the Lucas and Sargent strategy. The paper goes on to propose and to illustrate a strategy for positive economic analysis that incorporates choice-theoretical modelling of policy. Such modelling can allow better forecasting, but it also shifts attention away from policy actions and their effects and towards the more fundamental relation between the policymaker's constraints and targets and economic outcomes. The forecasting problem in a choice-theoretic model of policy concerns the effects of hypothetical realizations of variables that determine the policymaker's constraints and targets. The analysis of counter factuals in this context recognizes that the parameters of the policy process are not invariant with respect to the processes that generate these exogenous variables. A program of positive economics that includes choice-theoretic modelling of policy also preserves a distinct role for policy advice as part of the process being modelled.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1381.

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Date of creation: Jun 1984
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Handle: RePEc:nbr:nberwo:1381

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  1. Gertler, Mark, 1982. "Imperfect Information and Wage Inertia in the Business Cycle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(5), pages 967-87, October.
  2. Thomas J. Sargent & Neil Wallace, 1974. "Rational expectations and the theory of economic policy," Working Papers, Federal Reserve Bank of Minneapolis 29, Federal Reserve Bank of Minneapolis.
  3. Salih Neftci & Thomas J. Sargent, 1975. "A little bit of evidence on the natural rate hypothesis from the U.S," Working Papers, Federal Reserve Bank of Minneapolis 83, Federal Reserve Bank of Minneapolis.
  4. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  5. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  6. Robert P. Flood & Peter M. Garber, 1981. "A Model of Stochastic Process Switching," NBER Working Papers 0626, National Bureau of Economic Research, Inc.
  7. Thomas J. Sargent, 1980. "Interpreting economic time series," Staff Report, Federal Reserve Bank of Minneapolis 58, Federal Reserve Bank of Minneapolis.
  8. Brunner, Karl & Cukierman, Alex & Meltzer, Allan H., 1983. "Money and economic activity, inventories and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 11(3), pages 281-319.
  9. Behzad T. Diba & Herschel I. Grossman, 1983. "Rational Asset Price Bubbles," NBER Working Papers 1059, National Bureau of Economic Research, Inc.
  10. Sargent, Thomas J, 1984. "Autoregressions, Expectations, and Advice," American Economic Review, American Economic Association, American Economic Association, vol. 74(2), pages 408-15, May.
  11. Herschel I. Grossman, 1980. "Rational Expectations, Business Cycles, and Government Behavior," NBER Chapters, in: Rational Expectations and Economic Policy, pages 5-22 National Bureau of Economic Research, Inc.
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Cited by:
  1. Robert J. Barro, 1984. "Rules versus Discretion," NBER Working Papers 1473, National Bureau of Economic Research, Inc.

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