Macroeconomics and Rational Expectations Hypothesis Essay

Submitted By ninachino
Words: 861
Pages: 4
Open Document
What are the main proposistions of the New Classical Macroeconomics?
Discuss one important policy implication.

It is assumed that the Great Depression gave birth to modern macroeconomics, after which Keynes put forward a new and revolutionary theory “General Theory of Employment, Interest and Money” (1936) to explain and provide a remedy for the challenges associated with this phenomena of severe unemployment and low economic activity. Although Keynes was successful in introducting the concept of demand – driven responses to correct problems associated with economic crisis undertaken by a more active role of Government to tackle the excesses of the free market, Keynesianism failed in explaining the periods of stagflation experienced in the Industrialised economies of the world, such as the US and UK and as a result New Classical Economics emerged in 1970.
The first phase of NCE can be traced back to the early workings of Robert Lucas, Thomas Sargent and Robert Barro – Producing an influencial paper titled “After Keynesian Macro Economics” debating reasons why the Keynesian Model had failed. They outlined the lack of microeconomic foundations in Keynes’s analysis incorporating this a mistaken expectations hypothesis to explain the theoretical failings of 1960, they also identified econometric flaws in Keynesian Macroeconomic Models to explain the grand-scale failures evident in economic history during the 1970’s.
Therefore central to the beliefs of NCE’s was a belief in building macroeconomic models based on firm microeconomic foundations, whilst incorporating traditionally classical ideas of the continuous clearing of perfectly competitive markets demonstrated through the flexibility of prices, However it should be noted that NCE is distinguished from Classicalists and Monetarists in their explanation of economic fluctuations through random shocks (Hillier 1991).
Most distinguishing of NCE thinking in 1970 was argueably the “Rational Expectations Revolution” (Taylor 1989) highlighting the importance of the behavior of individual economic agents and their assumptions and expectations, incorporating John Muths “Rational Expectations Hypothesis (1961) within their analysis of macroeconomic study. As expressed by Luca and Sargent who advocated “Equilibrium” Classical Models in which Markets always clear and ‘rational’ agents optimize (Snowdon and Vane 1997).
Leading on the formation of The ‘Surprise’ Aggregate Supply Function by Robert Lucas drawing on criticisms initially proposed by Friedman in his analysis of the Philips curve through his Natural Rate hypothesis (1968).
The inclusion of Rational Expecations, Continuous Market clearing and Aggregate Supply hypothesizes within new classical models produced five highly controversial policy implications. In this essay I will be debating The Policy Ineffectiveness Proposistion.

The Rational Expectations Hypothesis:

The REH is crucial to NCE thinking and is associated with the workings of John Muth (birth – death). The hypothesis can be explained as such, economic agents are known to form subjective expectations of economic variables (eg: anticipated Inflation), it is argued that this will coincide with the “true” or “objective” mathematical conditional expectations of those variables, John Muth (1961) argues that expectations since they are informed predicitions of future events are essentially the same predictions of the relevant economic theory” The understanding agents have of the workings of the economy is what he argues distinguishes how accurate and efficient their assumptions are.
NCE aim to give macro economics, micro foundations and this can be identified with there adaptation of the REH – As
Show More

Related Documents: Macroeconomics and Rational Expectations Hypothesis Essay

Adaptive vs Rational Expectations Essay example

Differentiate between Rational and Adaptive Expectations and clearly explain their role in focusing on future macro-economic variables 1. Rational Expectations The theory of rational expectations was first proposed by John F. Muth of Indiana University in the early 1960s. He used the term to describe the many economic situations in which the outcome depends partly on what people expect to happen. Rational expectations theory is an assumption in a model that the agent under study uses a forecasting…

Words 1457 - Pages 6

Study Guide for EC301 Essay

three problems. I have listed below an example of what your exam will look like. This is your final exam. Good luck on your final. You just need to study these questions and you will do well on your final exam. Tom Econ 301 Intermediate Macroeconomics Study Guide, Professor Thomas Hiestand, Park University Online, Final Exam (Weight 300 Points) ______________________________ Multiple choice Questions. (Weight 5 points each) Choose the best answer. 1) The unemployment rate is the…

Words 741 - Pages 3

Macroeconomics: Inflation and Aggregate Demand Essay

Macroeconomics IS-LM Basics A) The IS curve slopes downward and to the right. B) The LM curve slopes upward and to the right. C) The slope of the LM curve depends on the interest sensitivity of money demand. An elastic money demand function caused the LM curve to be relatively flat. An inelastic money demand function caused the LM curve to be steep. D) The slope of the IS curve depends on the slope of the investment function. If investment is highly interest elastic, then the IS curve…

Words 1564 - Pages 7

Essay about Christopher Sims Monetary Policy And It

the same time, Haavelmo published his seminal papers explaining the necessity of a probability approach to specifying and estimating empirical economic models (1944) and laying out an internally consistent approach to specifying and estimating macroeconomic time series models (1943a). Keynes’s irritated reaction to the tedium of grappling with the many numbers and equations in Tinbergen’s book finds counterparts to this day in the reaction of some economic theorists to careful, large-scale…

Words 9146 - Pages 37

Monetarism School Of Thought

and the relevancy in today’s society.­ At center of Monetarism is the government involvement in circulation of the money supply. The fluctuation in the supply influences the output of price levels of both short and long runs. “Monetarism is a macroeconomic school of thought that emphasizes (1) long-run monetary neutrality, (2) short-run monetary nonneutrality, (3) the distinction between real and nominal interest rates, and (4) the role of monetary aggregates in policy analysis. It is particularly…

Words 1998 - Pages 8

Essay on MACROECONOMICS CHAPTERS 19 3

MACROECONOMICS: CHAPTERS 19 - 33 1. Apply the "art of economic analysis" to your decision to attend college. What roles did rational self-interest, marginal analysis, and time and information play in the decision-making process? ANS: A key economic assumption is that individuals, in making choices, rationally select alternatives they perceive to be in their best interests. By rational, economists mean simply that people try to make the best choices they can, given the available information. People…

Words 7674 - Pages 31

Fins 2624 - Portfolio Management Notes Essay

It is commonly displayed graphically as the yield curve (graph that shows the relationship between yield and maturity). Nb. The shape of the yield curve can change over time as market participants continuously revise their expectations on future inflation, which is one of the key determinants of interest rates. 4 Cheryl Mew FINS2624 – Portfolio Management Semester 1, 2011 The Term Structure of Interest Rates offers investors an objective way of inferring future…

Words 14447 - Pages 58

Purchasing Power Paricity And The Law Of One Price

aim is to give rather good idea about the main problems regarding PPP and its foundation – the Law of One Price. Empirical evidence on LOP Early empirical literature on the validity of the law of one price finds little support in favour of the hypothesis. In recent years, however, evidence coming from the exploitation of new data sets, either in the form of panel data or longer time series data, tend to support the view that the law of one price does hold in the long run (Goldberg and Verboven,…

Words 3779 - Pages 16

Economics and Financial Markets Essays

Global Financial Crisis of 2008-09: Triggers, Trails, Travails, and Treatments † Ganti Subrahmanyam * The present world economy has, increasingly, been interconnected in terms of small units such as industries, regions and national economies as discontinuous systems. Changes in these systems have varied impact across the world economies. This paper tries to trace out various triggers, trails and travails of the present crisis, with a view to suggest solutions or treatments for the global financial…

Words 8163 - Pages 33

Solution Manual-Investment Essay

Part B END-OF-CHAPTER SOLUTIONS Fundamentals of Investments, 5th edition Jordan and Miller Chapter 1 A Brief History of Risk and Return Concept Questions 1. For both risk and return, increasing order is b, c, a, d. On average, the higher the risk of an investment, the higher is its expected return. 2. Since the price didn’t change, the capital gains yield was zero. If the total return was four percent, then the dividend yield must be four percent. 3. It is impossible…

Words 22203 - Pages 89