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The Role of Expectations in the Choice of Monetary Policy

  • John B. Taylor

This paper reviews and contrasts different views about the role of expectations in policy research and practice. Recently, two widely different views seem to have dominated the analysis of policy questions.One view, which is referred to as the "new classical macroeconomic"view, is that expectations overwhelm the influence of monetary policy.The other view, which is referred to as the "Keynesian" macroeconomic view, is that expectations are unimportant because people do not adjust to expectations of policy change. The paper argues that both these views are misleading. It advances a new view of the role of expectations that is still emerging from current macroeconomic reearch. The new view recognizes the importance of contractual arrangements which prevent a modern economy from adjusting instantaneously to policy changes, even if they are expected. But it also emphasizes that forward-looking expectations influence how these arrangements are set up and how they evolve over time. Recent criticisms of this new view are reviewed, and examples are given to illustrate how quantitative methods that incorporate this view can be used in practice.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1044.

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Date of creation: Dec 1982
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Publication status: published as Taylor, John B. "The Role of Expectations in the Choice of Monetary Policy." Monetary Policy Issues in the 1980s, Economic Symposium Conference Proceedings August 9-10, 1982, pp. 47-76. Kansas City: Federal Reserve Bank of Kansas City, (1982).
Handle: RePEc:nbr:nberwo:1044
Note: EFG
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  1. Canzoneri, Matthew B., 1980. "Labor contracts and monetary policy," Journal of Monetary Economics, Elsevier, vol. 6(2), pages 241-255, April.
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  10. 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.
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  14. Robert E. Hall, 1980. "Employment Fluctuations and Wage Rigidity," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 91-142.
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  18. Frederic S. Mishkin, 1980. "Does Anticipated Monetary Policy Matter? An Econometric Investigation," NBER Working Papers 0506, National Bureau of Economic Research, Inc.
  19. Peter M. Garber, 1981. "Transition from Inflation to Price Stability," NBER Working Papers 0728, National Bureau of Economic Research, Inc.
  20. Willem H. Buiter & Ian Jewitt, 1980. "Staggered Wage Setting without Money Illusion: Variations on a Theme of Taylor," NBER Working Papers 0545, National Bureau of Economic Research, Inc.
  21. Carl E. Walsh, 1982. "Interest Rate Volatility and Monetary Policy," NBER Working Papers 0915, National Bureau of Economic Research, Inc.
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  23. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
  24. Alan S. Blinder, 1980. "Monetary Accommodation of Supply Shocks under Rational Expectations," NBER Working Papers 0464, National Bureau of Economic Research, Inc.
  25. Mussa, Michael L, 1977. "The Welfare Cost of Inflation and the Role of Money as a Unit of Account," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 9(2), pages 276-86, May.
  26. Begg, David Knox Houston, 1982. "Rational Expectations, Wage Rigidity and Involuntary Unemployment: A Particular Theory," Oxford Economic Papers, Oxford University Press, vol. 34(1), pages 23-47, March.
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  28. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.
  29. Rudiger Dornbusch, 1980. "Exchange Rate Rules and Macroeconomic Stability," NBER Working Papers 0473, National Bureau of Economic Research, Inc.
  30. John F. Boschen & Herschel I. Grossman, 1981. "Tests of Equilibrium Macroeconomics Using Contemporaneous Monetary Data," NBER Working Papers 0558, National Bureau of Economic Research, Inc.
  31. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  32. Taylor, John B, 1981. "Stabilization, Accommodation, and Monetary Rules," American Economic Review, American Economic Association, vol. 71(2), pages 145-49, May.
  33. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
  34. Tobin, James, 1981. "The Monetarist Counter-Revolution Today-An Appraisal," Economic Journal, Royal Economic Society, vol. 91(361), pages 29-42, March.
  35. Okun, Arthur M, 1980. "Rational-Expectations-with-Misperceptions as a Theory of the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 817-25, November.
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