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Rational Expectations and the Role of Monetary Policy: Some Tests Based on the Fisher Equation

  • Ali F. Darrat
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    This paper tests, for the United Kingdom, the Lucas/Sargent and Wallace proposition that inflation influences real output if it is unexpected. Rational estimates of expected and unexpected inflation are derived using the Fisher/Fama hypothesis regarding the relationship between nominal (market) interest rates and expected inflation, but where real interest rates are allowed to vary. The empirical results, based on a modified real output model, do not contradict the Lucas/Sargent and Wallace proposition. As such, these results cast doubts on the usefulness of systematic inflationary (monetary) policy for stabilizing the real side of the British economy even in the short run.

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    Article provided by Eastern Economic Association in its journal Eastern Economic Journal.

    Volume (Year): 14 (1988)
    Issue (Month): 3 (Jul-Sep)
    Pages: 211-219

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    Handle: RePEc:eej:eeconj:v:14:y:1988:i:3:p:211-219
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    1. Evans, Paul, 1985. "Do Large Deficits Produce High Interest Rates?," American Economic Review, American Economic Association, vol. 75(1), pages 68-87, March.
    2. Alan S. Blinder, 1980. "Inventories and the Structure of Macro Models," NBER Working Papers 0515, National Bureau of Economic Research, Inc.
    3. Sargent, Thomas J, 1976. "A Classical Macroeconometric Model for the United States," Journal of Political Economy, University of Chicago Press, vol. 84(2), pages 207-37, April.
    4. Laumas, G S & McMillin, W D, 1984. "Anticipated Fiscal Policy and Real Output," The Review of Economics and Statistics, MIT Press, vol. 66(3), pages 468-71, August.
    5. Canzoneri, Matthew B., 1980. "Labor contracts and monetary policy," Journal of Monetary Economics, Elsevier, vol. 6(2), pages 241-255, April.
    6. Fama, Eugene F, 1975. "Short-Term Interest Rates as Predictors of Inflation," American Economic Review, American Economic Association, vol. 65(3), pages 269-82, June.
    7. Fair, Ray C, 1979. "An Analysis of the Accuracy of Four Macroeconometric Models," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 701-18, August.
    8. Farley, John U. & Hinich, Melvin & McGuire, Timothy W., 1975. "Some comparisons of tests for a shift in the slopes of a multivariate linear time series model," Journal of Econometrics, Elsevier, vol. 3(3), pages 297-318, August.
    9. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
    10. Robert J. Barro & Mark Rush, 1979. "Unanticipated Money and Economic Activity," NBER Working Papers 0339, National Bureau of Economic Research, Inc.
    11. Koskela, Erkki & Viren, Matti, 1980. "New international evidence on output-inflation tradeoffs : A note," Economics Letters, Elsevier, vol. 6(3), pages 233-239.
    12. Robert J. Barro, 1976. "Unanticipated Money Growth and Unemployment in the United States," Working Papers 234, Queen's University, Department of Economics.
    13. Amihud, Yakov, 1982. "Unanticipated inflation and economic activity," Economics Letters, Elsevier, vol. 9(4), pages 327-335.
    14. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
    15. Katz, E, 1980. "Interest Rates as Predictors of Inflation in Small Economies: Some Empirical Results," Empirical Economics, Springer, vol. 5(3/4), pages 255-61.
    16. Ali F. Darrat, 1985. "Unanticipated Inflation and Real Output: The Canadian Evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 18(1), pages 146-55, February.
    17. Small, David H, 1979. "Unanticipated Money Growth and Unemployment in the United States: Comment," American Economic Review, American Economic Association, vol. 69(5), pages 996-1003, December.
    18. 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.
    19. Brian Motley, 1983. "Real interest rates, money and government deficits," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 31-45.
    20. Kugler, Peter, 1982. "The Dynamic Relationship between Interest Rates and Inflation: A Empirical Investigation," Empirical Economics, Springer, vol. 7(3-4), pages 125-37.
    21. McGee, Robert T & Stasiak, Richard T, 1985. "Does Anticipated Monetary Policy Matter? Another Look," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 16-27, February.
    22. Arak, Marcelle, 1977. "Some International Evidence on Output-Inflation Tradeoffs: Comment," American Economic Review, American Economic Association, vol. 67(4), pages 728-30, September.
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