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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.

Suggested Citation

  • Herschel I. Grossman, 1984. "Counterfactuals, Forecasts, and Choice-Theoretic Modelling of Policy," NBER Working Papers 1381, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1381
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    References listed on IDEAS

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    1. Sargent, Thomas J, 1981. "Interpreting Economic Time Series," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 213-248, April.
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    7. Behzad T. Diba & Herschel I. Grossman, 1983. "Rational Asset Price Bubbles," NBER Working Papers 1059, National Bureau of Economic Research, Inc.
    8. Sargent, Thomas J. & Wallace, Neil, 1976. "Rational expectations and the theory of economic policy," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 169-183, April.
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    Cited by:

    1. Herschel I. Grossman, 1987. "A Generic Model of Monetary Policy, Inflation, and Reputation," NBER Working Papers 2239, National Bureau of Economic Research, Inc.
    2. Robert J. Barro, 1984. "Rules versus Discretion," NBER Working Papers 1473, National Bureau of Economic Research, Inc.
    3. Grossman, Herschel I. & Van Huyck, John B., 1986. "Seigniorage, inflation, and reputation," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 21-31, July.

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