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Rational Expectations and Policy Evaluation in Macroeconometric Models

Working Paper 82 | Published May 1, 1977

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Author

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Paul A. Anderson

Rational Expectations and Policy Evaluation in Macroeconometric Models

Abstract

This paper puts forward a method of policy simulation with an existing macroeconometric model under the maintained assumption that individuals form their expectations rationally. This new simulation technique grows out of Lucas' criticism that standard econometric policy evaluation permits policy rules to change but doesn't allow expectations mechanisms to respond as economic theory predicts they will. This technique is applied to versions of the St. Louis Federal Reserve model and the FRB-MIT-Penn model to simulate the effects of different constant money growth policies. I shall briefly summarize the current practice of policy evaluation and the Lucas critique in the first section. The second section includes an explanation of the method I propose. The third section includes the two illustrative applications. In the conclusion, I cannot resist the temptation to offer some opinions about the use and usefulness of econometric models.