AMERICAN ECONOMIC ASSOCIATION MAY /979 of such a policy but the record of previous The formation of expectations is one dimen- price control programs does not seem impres- sion in which the private sector might operate less (or even m nore? effic iciently than the Modern courses in macroeconomics utilize government- other seemingly comparable di price theory to a considerable extent. Howev- mensions would include the range of permiss er, these "micro foundations"are usually ble contracts, coordination of trades, pro- limited to the formulation of sectoral supply duction of information, responsiveness of and demand functions, rather than to the supply and demand to money illusion, and so analysis of"general equilibrium. Despite on. However, it is possible to produce Keyne oddities in some earlier treatments of labor sian policy conclusions in models that incor- supply, the serious problem with non- porate rational expectations, but which market-clearing-type models are not in the contain some other departures from sensible characterization of supply and demand, but behavior, for example, arbitrarily fixed nomi- rather in the neglect of the other branch of nal wages, or money illusion either in supply price theory: namely, supply equals demand. and demand functions or in the form of Supply not equal to demand as a basis for private labor contracts. Thus the nature of the quantity determination in non- market-cl formation of expectations seems to be an models is not on the same analytical level important issue within the general context of as supply equals demand. The latter mechan- the efficiency of private arrangements rela- ism implies that-at least in a direct sense- tive to governmental actions, but it is this the private market manages to exhaust trades general concept of relative efficiency that that are to the perceived mutual advantage of seems to be crucial in evaluations of policy the exchanging parties. On the other hand, by activism mechanically leaving opportunities for mu Monetary control is one area in which a tually desirable trades, the non-market-clear- strong governmental role is generally ac- ng approach makes government policy activ- cepted. I abstract here from important issues sm much too easy to justify. When the that involve the transactions benefits of a arbitrariness of supply unequal to demand is generalized medium of exchange and the replaced by a serious explanation, such resource costs that can be saved by using a imperfect information about exchange oppor- fiat standard for money, rather than a tunities, for the failure of private markets to commodity standard. Even with this abstrac achieve some standard of efficency, the case tion a rationale for government involvement or government intervention becomes much in monetary control can be constructed on less obvious business cycle grounds--in particular, from a Let me now consider some specific issues consideration of the Phillips curve, which I relating to information and macro policy. I view here as a representation of the respon begin with the role of expectations in macro siveness of economic activity to unanticipated nodels. Thanks especially to the work of movements in money and the absolute price Robert lucas, we have a much better idea of level. The potential for confusion between the significance of well-informed private ex- absolute and relative price changes in a mone- pectations in macro analysis. This ary economy, which is a possible basis for the cance arises in at least three areas: positive Phillips curve, seems to justify some public analyses of the effects of monetary and other control over the quantity of nominal money hocks on economic activity, analyses of the A major empirical finding is the central role of government polices; and evaluations role that monetary shocks have, in fact and carrying out of econometric estimation. played in business cycles. The greater year Nonetheless, I agree with the view that to-year stability of the underlying monetary rational vS. nonrational expectations is not mechanism in the United States since World per se the key division between Keynesian and War II-which involves a substantial in- non-Keynesian models and, accordingly, is crease in government regulation--has led to a not the essential basis for a division between smaller amplitude of business fluctuations in activist and nonactivist policy conclusions. comparison to those of either the interwar