Ngân hàng, tín dụng - Chapter 27: Rational expectations: theory and policy implications

1Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Chapter 27 Rational Expectations: Theory And Policy Implications Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-2 Learning Objectives • Differentiate between rational and adaptive expectations • Explain why monetary policy is ineffective under rational expectations • Realize the importance of central bank credibility under rational expectations • Define monetary policy’s influence on interest rates under different expectations regimes Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-3 Introduction • Expectations in the economy play a significant role in the outcome of monetary policy – Inflationary expectations enter into wage agreements and, therefore, determine the shape of the aggregate supply curve and the Phillips curve trade-off – Expectations of monetary policy affect the timing of interest rate responses to changes in the money supply 2Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-4 Introduction (Cont.) • The models developed in earlier chapters assumed that expectations of the future are based on the past • However, this assumption ignores other pieces of information that might be important to a more accurate estimate of future Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-5 When are Expectations Rational? • Adaptive expectations – Assumes that inflation in the future is an extrapolation of recent price trends – Thus, if inflation has been on the increase, this suggests that people expect inflation to continue to go up – This ignores any possible countercyclical policy response by the Federal Reserve Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-6 When are Expectations Rational? (Cont.) • Rational expectations – People will use all available information to formulate expectations of economic variables— inflation, interest, money supply – Individuals have strong incentives to make rational forecasts and will act accordingly – If their expectations are consistently wrong, they will re-formulate the expectations model to include other variables 3Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-7 When are Expectations Rational? (Cont.) • Rational expectations (Cont.) – Therefore, increasing inflation would lead to a rational conclusion that the Federal Reserve will engage in restrictive monetary policy to reduce inflationary pressure – Such expectations would be considered rational because they include information that is relevant for properly forecasting inflation Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-8 Anticipated Versus Unanticipated Monetary Policy • Rational expectations combined with flexible prices and wages concludes that anticipated monetary policy will not impact economic activity • Keynesian upward sloping aggregate supply curve – Wages rise more slowly than prices since inflationary expectations lag behind actual inflation – Increasing money supply leads to higher output and less unemployment as firms increase output Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-9 Anticipated Versus Unanticipated Monetary Policy (Cont.) • Monetarists vertical aggregate supply curve – With an anticipated increase in money supply, subsequent inflation will also be anticipated – With full flexibility of wages and prices, workers insure wages move up simultaneously with prices – Under those circumstances, there will not be any increase in output or reduction in unemployment as a result of anticipated growth of money stock 4Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-10 Anticipated Versus Unanticipated Monetary Policy (Cont.) • Assume money growth is not anticipated – Increased aggregate demand leads to higher prices that are not anticipated – Wages will lag prices and business firms hire more workers to expand output – Result is higher output and lower unemployment when money supply growth is not anticipated Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-11 eP1 Anticipated Versus Unanticipated Monetary Policy (Cont.) • Figure 27.1 – Two upward sloping aggregate demand curves whose location depends on expected price level – The initial equilibrium point is P1 and YE, consistent with D1 and S( ) – An increase in the money supply shifts the aggregate demand curve from D1 to D2 – The output of the economy will be pushed beyond YE, with lower unemployment, as long as the inflationary impact is not fully anticipated Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-12 FIGURE 27.1 Anticipated monetary policy shifts aggregate supply along with aggregate demand, leaving GDP unchanged. 5Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-13 eP2 Anticipated Versus Unanticipated Monetary Policy (Cont.) • Figure 27.1 (Cont.) – Once change in money supply is fully anticipated, the aggregate supply curve will shift to S( ) – Under the assumption of rational expectations, the price level will increase to P2, and the economy will again be operating at full employment, YE – Thus the end result of an anticipated change in the money supply is an unchanged level of economic activity with a higher price level Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-14 Implications for Stabilization Policy • Stabilization policy usually falls under the category of anticipated policy • Therefore, it is generally correctly anticipated through rational expectations • Systematic policies are useless • Because of rational expectations, only “erroneous” (completely unanticipated) changes in the money supply influence the level of economic activity Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-15 Implications for Stabilization Policy (Cont.) • This suggests that the debate between rules versus discretion is irrelevant, neither policy employed by the Federal Reserve can influence real economic activity • The outcome of the rational expectations world is decidedly classical-Monetarist rather than Keynesian 6Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-16 Implications for Stabilization Policy (Cont.) • Rational expectations is the main component of new classical macroeconomics • However, sluggish adjustments in the labor market are part of the implicit and explicit contractual agreements in the labor market • In this case, wages may lag behind prices even if expectations of inflation are formed rationally and the result is the Phillips curve trade-off between employment and inflation Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-17 Inflation, The Phillips Curve, and Credibility • With an upward sloping aggregate supply curve, policymakers could increase level of economic activity and reduce unemployment as long as they were ready to tolerate an increase in inflation • Monetarists argue that in the short-run this might be so, but after expectations have adjusted, the aggregate supply curve is vertical with no permanent trade-off Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-18 Inflation, The Phillips Curve, and Credibility (Cont.) • Rational expectations theory pushes the monetarists’ long-run analysis into short run by transforming a series of upward-sloping aggregate supply curves into a vertical one • This condition, which is shown in Figure 27.2, demonstrates that simultaneously shifting the aggregate supply and demand curves, economy remains at “natural” full employment level, YFE, at increasingly higher prices 7Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-19 FIGURE 27.2 Anticipated monetary policy can affect only the price level. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-20 Inflation, The Phillips Curve, and Credibility (Cont.) • Keynesians argue that wage and price rigidity in the economy prevent the aggregate curves from responding as quickly as rational expectations would suggest • The rational expectations adjustment model presents a possibility that reducing inflation is accomplished painlessly – Small increase in unemployment and little lost output as Federal Reserve reduces money supply Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-21 Inflation, The Phillips Curve, and Credibility (Cont.) • Painless reduction of inflation (Cont.) – As long as the Federal Reserve’s policy is credible, the leftward shifts in the aggregate demand schedule produced by a reduction in the money supply are matched by equal leftward shifts in the aggregate supply curve – Result is a decrease in prices with the economy remaining at the full employment level, YFE 8Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-22 Inflation, The Phillips Curve, and Credibility (Cont.) • Above scenario of reducing inflation depends on the credibility of the Federal Reserve – If public suspects Fed will not stay the course because of concern for increased unemployment, might conclude Fed will reverse their policy – The result is that the expected price level will not fall, the aggregate supply curve will not shift leftward, resulting in a reduction in output and increased unemployment Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-23 Interest Rates and Anticipated Monetary Policy • The rational expectations message for interest rates is not much brighter than for countercyclical policy in general • The Monetarists acknowledge an increase in the money supply might temporarily reduce interest (liquidity effect), however, inflationary expectations will ultimately drive nominal rates above real rates Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-24 Interest Rates and Anticipated Monetary Policy (Cont.) • With rational expectations, an anticipated increase in the money supply immediately leads to higher nominal interest rates • The only way that monetary policy can reduce interest rates in the short-run is to have a completely unexpected expansion in the money supply 9Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 27-25 Interest Rates and Anticipated Monetary Policy (Cont.) • Since prices in financial markets are not set by contractual agreement and respond very quickly to changes in supply and demand, rational expectations is a more relevant theory than in explaining labor markets adjustments