Rational expectations and M2 demand

This essay expands on existing studies of M2 money demand. It differs in that it applies a rational expectations approach to an adaptive expectation model. Unlike the adaptive expectations models, the author includes an explanatory variable for expectations of future inflation. The expectation variables used are: the actual inflation rate (t + 1) and the Livingston Survey from the Philadelphia Fed. By using the different measures of expectations the author is able to compare several adaptive expectations models that appear in the literature and the rational expectations models for fit and forecast ability. The empirical results are such that the importance of including the rational expectations variable is evident even though the overall fit of the equation is comparable to one of the existing adaptive expectations models.     

Rational expectations and the instability of bond-financing

Models involving the government budget constraint are generally unstable when deficits are bond-financed; while rational expectations models involve restrictions which preclude unstable solutions. This note integrates these approaches and shows that rational expectations is inconsistent with convergence when deficits are bond-financed.     

Rational expectations and the short-run Phillips curves

The purpose of the present paper is to study certain derivable implications of the rational expectations hypothesis (REH) in the context of a simultaneous wage-price model of the U.S. economy and to subject the REH to statistical tests. The empirical evidence indicates that implementation of the REH in the context of these models does wipe out the conventional short-run Phillips curves, and the assumption that public expectations of future rates of inflation are true conditional mathematical expectations based on all available information is indeed borne out quite well against its alternatives.     

Rational expectations models with partial information

This paper provides a general solution to the problem of partial information in linear discrete time stochastic rational expectations models. The full information case is first reviewed and the solution of Blanchard and Kahn [4] extended. Then we consider the problem of partial information for the special case where only the current values of some variables are unobserved. The solution can be treated as a straightforward extension to the full information case. In the general problem where in addition to some current variables being unobserved, certain variables are unobserved for all lags, we provide a solution which requires the use of Kalman filters. The paper concludes by examining the covariance properties of the rational expectations system under different informational assumptions.     

Rational expectations in the overlapping generations model

This paper reports results on the character of the rational expectations equilibria of a stochastic overlapping generations model with heterogenous markets. The model considered is a stationary overlapping generations model in which the endowments of young agents are subject to i.i.d. random shocks. The main result shown is that if there are l > 1 commodities traded in every period, then for most preferences, the rational expectations equilibrium stochastic process of prices and allocations necessarily exhibits serial correlation. This is in marked contrast to the one commodity model in which there always exists an equilibrium which is measure isomorphic to the endowment process.     

Dynamic demand,consumers' expectations and monopolistic resource extraction: An application to OPEC pricing policies

This paper introduces intertemporal decision making of the consumers, including different price expectations (myopic, rational), into the framework of monopolistic resource depletion. This adds another dynamic feature which has been neglected by and large by the literature. In particular a differential game of the von Stackelberg type between consumers and an oil extracting monopoly is considered. Analytical solutions are obtained when demand is linear. This framework is then empirically applied to derive and reconcile rational OPEC strategies and past behaviour.This paper has been presented at the Third Annual Conference of the European Economic Association in Bologna. I like to thank an anonymous referee and Dr. Ohogu for valuable comments.     

Rational expectations,difference of opinions and asset pricing

This article applies the concept of relative overconfidence (the measure of how heavily investors depend on others’ information) to combine the rational expectations equilibrium (REE) and difference of opinions (DO) models. And we discuss the effects of relative overconfidence on asset price efficiency and trading volume. We find that when investors hold assets to maturity, relative overconfidence has no effect on price efficiency and trading volume; however, when investors speculate, relative overconfidence reduces price informativeness and trading volume, because investors will reckon asset prices as more noisy and find it meaningless to speculate on capital gains based on their private information. Our results highlight the role of speculation in differentiating REE and DO models and influencing the effects of overconfidence.     

Rational expectations equilibria of economies with local interactions

We consider general economies in which rational agents interact locally. The local aspect of the interactions is designed to represent in a simple abstract way social interactions, that is, socioeconomic environments in which markets do not mediate all of agents’ choices, which might be in part determined, for instance, by family, peer group, or ethnic group effects. We study static as well as dynamic infinite horizon economies; we allow for economies with incomplete information, and we consider jointly global and local interactions, to integrate e.g., global externalities and markets with peer and group effects. We provide conditions under which such economies have rational expectations equilibria. We illustrate the effects of local interactions when agents are rational by studying in detail the equilibrium properties of a simple economy with quadratic preferences which captures, in turn, local preferences for conformity, habit persistence, and preferences for status or adherence to aggregate norms of behavior.     

Rational expectations in microeconomic models: An overview

This paper is an expository introduction to several topics of current research in the general equilibrium theory of rational expectations. More specifically, we discuss the existence of exact and approximate rational expectations equilibria, the implementation of equilibria, the behavior of learning and smoothing processes by which traders construct expectations from repeated observations of the market, and the lagged use of the information revealed by prices in an intertemporal sequence of markets. The purpose of this discussion is to introduce papers on these topics appearing in the Journal of Economic Theory Symposium on Rational Expectations in Microeconomic Models.     

Rational expectations,market shocks,and the exchange rate

The world economy has been subjected to numerous real shocks in recent years. In addition, purchasing-power parity seems to have collapsed. Critics of the monetary approach to the exchange rate have been quick to draw attention to these facts. This paper extends the basic framework of the monetary approach so that it provides a useful tool for explaining the impact of real shocks on the exchange rate and so that it is compatible with the existence of significant deviations from purchasing-power parity. The real shocks that are discussed include changes in commercial policy, the terms of trade, and productivity. It is demonstrated that real shocks influence the exchange rate through two distinct channels—a real-income channel and a deviations from purchasing-power-parity channel.     

Rational expectations macro models with possible steady-state inflation andunemployment

Consider an economy exhibiting the conventional IS-LM relationships, Phillips curve type price adjustment equations, and rational inflationary expectations. We demonstrate that starting from the disequilibrium situation of either the Keynesian unemployment or the demand inflation type in which money is nonneutral, the economy converges to an equilibrium situation in which all markets clear. On the other hand, starting from the disequilibrium situation of the classical unemployment type in which money is nonneutral, the economy converges to a state of rest in which the goods and the labor markets remain out of equilibrium. However, money is neutral at this state of rest.     

Rational expectations and fixed-event forecasts: An application to UK inflation

This paper tests a version of the rational expectations hypothesis using ‘fixed-event’ inflation forecasts for the UK. Fixed-event forecasts consist of a panel of forecasts for a set of outturns of a series at varying horizons prior to each outturn. The forecasts are the prediction of fund managers surveyed by Merrill Lynch. Fixed-event forecasts allow tests for whether expectations are unbiased in a similar fashion to the rest of the literature. But they also permit the conduct of particular tests of forecast efficiency - whether the forecasts make best use of available information - that are not possible with rolling-event data. We find evidence of a positive bias in inflation expectations. Evidence for inefficiency is much less clear cut.First version received: June 2002/ Final version received: November 2003We would like two anonymous referees and an editor for comments that have significantly improved the paper. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England.     

Rational expectations and the demand for money: A nonparametric approach

This paper tests the U.S. demand for money for evidence of the effect of rational expectations of the income and interest rate variables that enter as arguments into that function. The data employed are simple-sum and Divisia aggregates, and the nonparametric tests are of the identification and information orthogonality of the various monetary measures. The Akaike Criterion is used to distinguish among the alternative specifications. While non-rationality is the typical result, Divisia aggregates appear to be more “rational” than simple sum. There is evidence of mean-reversion in interest rates as well.     

Rational expectations estimation of macroeconomic models: some Monte Carlo results

This paper analyzes the relative performance of alternative estimation methods for rational expectations macroeconomic models using a Monte Carlo approach. The methods studied include a single equation instrumental variable method most often attributed to McCallum, a full information substitution method proposed by Taylor and an efficient full information technique developed by Wickens. In general, the results of our Monte Carlo experiments indicate that although the full information methods tend to perform bettern than the single equation techniques, the gains of efficiency are relatively modest. However, in some experiments involving misspecification errors, the single equation method outperforms the full information estimators.     

Rational expectations,the government budget constraint,and the optimal money supply

A stylized macroeconomic model incorporating a surprise supply function is examined. Extension of the model to recognize the government budget constraint makes it clear that random elements must enter into the determination of some policy variable in the face of exogenous shocks elsewhere in the model. Allowing these random elements to enter into the money supply may be a useful automatic countercyclical policy contrary to the usual inference that a deterministic money supply policy will be better.