The ineffectiveness of macro-stabilization policy with rational expectations
The Rational Expectations theory is that the Cenral Bank changes the money supply in response to employment conditions. The public will see these changes and respond by changing price and supply. This will then create a neutral monetary policy. Prices and wages can affect the expections of nominal values. Even with these rational expectations, monetary policy can stabilize output. Some economist believe that research should only test hypotheses based on models of behavior and disregard personal norms of how individuals expect others to behave. However, this would only work if economic tests were powerful, which they are not for many reasons. The three most important parts of macro models are consumption behavior, investment behavior, and wage and price behavior. These all show violations, but instead of economists using norms to explain them they use norm-less models. This consistently prevents economist from explaining actions and decisions.
The problem with rational expectations for inflation is monetary policy that was suppose to stabilize will instead be neutral.
All five neutralities:
- Ricardian equivalence
- Life cycle hypothesis
- Cash Flow and Investment
- Natural rate hypothesis and the role of rational expectations
- Norms
The important point is that norms play a huge role in macroeconomics and should be further researched!
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