Rational Expectations and macr lics in 1984 OR。 Robert J. barro Annual Meeting of the American Economic Association. May, 1984), pp 179-1 ety-Sixth The American Economic Review, Vol. 74, No 2, Papers and Proceedings of the Nin Stable url: ttp: //inks. istor org/sici?sici=0002-8282%28198405%02974%3A2%3C179%3AREAMI1%3E2.0.C0%03B2-H The American Economic Review is currently published by American EconomIc Association Your use of the jStoR archive indicates your acceptance of jSTOR's Terms and Conditions of Use, available at http:/lwww.istororg/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyouhaveobtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JStOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support(@jstor.org http:/www.jstor.org Fri mar1610:53:192007
Rational Expectations and Macroeconomics in 1984 Robert J. Barro The American Economic Review, Vol. 74, No. 2, Papers and Proceedings of the Ninety-Sixth Annual Meeting of the American Economic Association. (May, 1984), pp. 179-182. Stable URL: http://links.jstor.org/sici?sici=0002-8282%28198405%2974%3A2%3C179%3AREAMI1%3E2.0.CO%3B2-H The American Economic Review is currently published by American Economic Association. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/aea.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor.org. http://www.jstor.org Fri Mar 16 10:53:19 2007
WHAT SURVIVES OF THE RATIONAL EXPECTATIONS REVOLUTION? Rational Expectations and Macroeconomics in 1984 By roBERT J barro* One of the cleverest features of the ra- booms. There are also some intriguing impli ional expectations revolution was the ap monetary policy--namely, th propriation of the term"rational "Thereby, systematic part does not matter(aside from he opponents of this approach were forced the inflation tax), and the erratic behavior into the defensive position of either being tends to be harmful irrational or of modeling others as irrational, The rational expectations theory of busi- neither of which are comfortable positions ess fluctuations and the empirical work that for most economists. In fact, much of the relates to this theory are surely interesting rational expectations view-that expecta- and suggestive. However, it seems a fair as tions are formed sensibly given the informa- sessment that this research has not provided tion that people have(and are motivated to a definitive analysis of either monetary non- acquire)has been generally accepted. This neutrality or of the business cycle more gen viewpoint has permanently and usefully al- erally. Consequently, this work has received tered the way that most macroeconomists much criticism, some of which has even been build models and carry out evaluations of insightful. But I should stress that the serious shifts in governmental behavior In this sense problems all arise in the attempt to explain the rational expectations revolution has tri- the nonneutrality of money, which is surely umphed decisively the hardest problem in macroeconomics The phrase, rational expectations macro- Some recent research, which I discuss later, economics, also suggests a particular theory suggests that the solution to this problem of business fluctuations. This well-known may not be as crucial for the understanding theory shows how incomplete information of business cycles as many of us used to about the quantity of money and the general think price level can lead to nonneutrality of mon- One troublesome aspect is the place of ey. Specifically, changes in money lead to rational expectations macroeconomics in the temporary confusions between general and often political debate over Keynesian eco- relative prices, which lead in turn to adjust- nomics. At least implicitly, many people feel ments of production and employment. Some that what's bad for the rational expectations extended versions of this model allow the viewpoint is good for the Keynesian one, and real effects of monetary disturbances to per- vice versa. But it is hard to see how the sist over periods that are long enough to problems in using the rational expectations correspond to real world recessions and approach to explain monetary nonneutrality an alleviate the theoretical and empirical shortcomings of the Keynesian model. This r of Economics, University of Chicago, 1126 model is basically an incomplete theory that E. 59th Street, Chicago, IL 60 rovides many prescriptions for activist expectations, although amidst sticky prices and rationed macro policies, but which retains some seri inconsistencies with the rational behar al consistency of this procedure-as Laurence Weiss ior of individuals. Specifically, no one has puts it, If one is willing to positreasonable'descrip- been able to use elements such as informa f how wages and prices are determined without tion and mobility costs-which are obvious that expectations can be similarly candidates for explaining the coordination oblems of private markets-in order te l79
80 AEA PAPERS AND PROCEEDINGS MAY/984 generate results that look Keynesian. Simi- The other main objection to real business larly, the Keynesian model still has its dif- cycle theory is that it fails to address the link ficulties with inflation and supply shocks between money and real variables. At least difficulties that were the prime reasons for through the 1930s, the main positive associa the widespread and growing dissatisfaction tion between monetary aggregates and real with this model since the late 1960s variables derives from fluctuations in the If we look beyond the issue of monetary quantity of financial intermediation-that is nonneutrality, then we do find areas of mac- the volume of deposits and loans-rathe roeconomics that use rational expectations than from shifts in the monetary base and in which important recent progress has In many cases, the economic contractions been made. One area concerns real theories were accompanied by banking panics, which of business fluctuations-that is, fluctuations tended to feature the suspension of convert in real economic activity that reflect underly- ibility between deposits and currency press skepticism that aggregate real shocks difficult to see why a sudden decline in the occur with sufficient size and frequency to quantity of financial intermediation would account for a major part of the business have adverse real consequences for the econ cycle. For exampl le, after mentioning the oil omy. In fact, a cutback in financial inter crises and harvest failures, one is often asked mediation is not so different from a negative to name the third example of an important shock to production functions, which is the real shock. In this regard, I find David type of disturbance that appears in real theo- Lilien's research(1982)to be particularly ries of business cycles. Thus, the main chal promising. He shows that greater dispersion lenge is to explain why the earlier financial in the shifts to technology and tastes-with system was subject to occasional crises-not no necessary aggregate bias-can lead to why these crises, once they occurred, would significant and persistent effects on the ag- have serious repercussions on output and gregates of output and employment. In employment. It seems likely that deposit in assessing the empirical significance of this surance plays an important role in this story approach, we could look at the major changes Even in the post-World War II period in patterns of international comparative ad there is evidence that much of the interplay vantage that have occurred since the early between money and real activity reflects 1970,s. These changes show up, for example, fluctuations in deposits and in credit aggre as a faster rate of decline in the share of U.S. gates, rather than the monetary base. Thus output that is accounted for by the manufac- money may serve more as an indicator of turing sector. We would look also at the changes in business conditions, rather than volatility in the relative prices of internation- as a major exogenous influence on real vari ally traded goods, which are not limited to ables. However, evidence on the interactions elative prices seem between the monetary base and real vari- to have a great deal to do with the gyrations ables still suggests some amount of monetary in real exchange rates over the last decade. nonneutrality, which we would like to ex- Overall, it seems that real theories are espe- plain. In fact, this type of interplay between cially promising for explaining the sharp monetary and real variables during relatively fluctuations in real economic activity and the minor recessions may be quantitatively in tendency for increases in unemployment rates line with the rational expectations models since the early1970’s which stress the role of incomplete informa tion about money and prices. Thus, we may be able to resolve the puzzle of moneta nonneutrality by arguing first, that much of 2One of the more remarkable recent developments is the empirical association between money and the view that long-term contracts can rescue the old real variables is not evidence of nonneutral activism. It is hard to see how the ability to contract could lessen the private econo ity, and second, that the existing theories can ability to deal with disturbances and thereby enhance account for the relatively small amount of the case for Keynesian macropolicies nonneutrality that remains
VOL.74 NO. 2 WHAT SURVIVES OF THE RATIONAL EXPECTATIONS REVOLUTION? Another area in which important progress ptimizing at each date with the current state has been made concerns fiscal variable always taken as given(which might call for that is, government expenditures, taxes and disallowing existing patents and defaulting deficits. Here, the rational expectations view- on existing debts). This viewpoint has im- point is consistent with real effects from some portant insights for the desirability of rules types of systematic macropolicies For exam- in the context of monetary and fiscal poli- ple, economic activity would generally re- cies. The gold standard and constitutional spond to changes in the level or timing of limits on money, taxes and spending can be government purchases and public services, as viewed from this perspective as possibly use well as to the timing of taxes if these levies ful rules. Further, if rules are absent, then are not lump sum. However, the"Ricardian the theory of discretionary policy provide Theorem"says that choices between deficits predictions about the outcomes for inflation, and lump sum taxes do not matter for real monetary growth and other variables. I variables. (They may or may not matter for other words, we can derive a positive theory the price level. of governmental behavior that complements There is empirical evidence that docu- the usual theory of individual behavior Pro- ments the expansionary effect on output from ceeding this way, we can account for the high government purchases, especially for the and variable inflation that prevails under the porary buildups that accompany present "unruly"structure for monetary ars. However, it is harder to verify the real policy. effects from shifts in the timing of non- lump It is easy for me to appreciate the recent sum taxes, probably because governments progress in macroeconomics since I have only typically tailor their debt-management poli- to recall the level of knowledge that pre cies to avoid major swings in tax rates. In vailed during my student days at Harvard. fact, this perspective leads to a useful posi- remember vividly a lecture when I was a new tive theory of deficits--namely, they are in- graduate student in 1966. The opening creased by wars and recessions and, it turns speaker announced gleefully that the busi out,by higher rates of expected inflation. ness cycle was dead. Then the main lecturer viewpoint explains U.s. defic sonably well since World War I, including Economic Advisers-told us how the won the experience for 1982-83. Finally, there is ders of fine-tuning in macropolicy had been little evidence that shifts in deficits are an used virtually to eliminate recessions. (He independent source of business fluctuations even divided the gain in GNP by the number (or of changes in interest rates). Thus, the of economists in the United States to show Ricardian Theorem seems to be in good how valuable each economist was, which s ape-and to have become remarkably re- made us students feel very warm and self- satisfied. )3 No doubt we are sorry that the As to more progress, our understanding of orld does not work this way, but it must be macropolicy has been expanded particularly progress to have found out. by Finn Kydland and Edward Prescott The truth is that in the mid-1960s there (1977), who brought out the essential distinc- was an artificial, essentially political con tion between rules and discretion. A rule sensus on the Keynesian model, which was fitments about future govern- not built on much supporting economic the- ental behavior, for example, to honor ory or empirical evidence. The evaporation atents on inventions or not to default on of that consensus produced a letdown among public debts. These commitments, which many macroeconomists, not to mention amount to a rule of law in the framing of policymakers and news reporters. But this governmental policy, can encourage efficient breakdown was necessary in order for us to behavior of individuals, such as to inven things and to hold the governments debt. Thus, there can be a gain from the govern- 'probably there should be a distinction here between ment's "tying its hands"in advance, rather the average economist and the marginal economist.But than following the discretionary approach of that falls into the domain of price theor
AEA PAPERS AND PROCEEDINGS MAY 1984 begin learning about the macroeconomy and REFERENCES o stimulate the development of superior methods of theoretical and empirical analy- Bernanke, Ben, Monetary Effects of the sis. Over the last fifteen years we have gener Financial Crises in the Propagation of ated a significant array of findings about the the Great Depression, " American Economic macroeconomy, and there is the promise of Review, June 1983, 73, 257-76 nuch more to come. Often people down- Lilien, David, " Sectoral Shifts and cyclical grade this progress because of a focus on the Unemployment, "Journal of Political Econ- one area-namely the nonneutrality of mon- August 82.90.777-93 ey-in which the most problems have arisen. Kydland, Finn and Prescott, Edward,"Rules But overall we are in much better shape in rather than Discretion: The Inconsistency macroeconomics -in terms of what we of Optimal Plans, " Journal of Political know and of knowing what we don' t know Economy, June 1977, 85, 473-9 than we were fifteen years ago. Why, even Weiss, Laurence, "Rational Expectations the undergraduate textbooks in macroeco- Models in Macroeconomics, "unpublished nomics are getting better University of Chicago, 1983
