Über die Autorin bzw. den Autor

Roman Frydman is professor of economics at New York University and the coauthor (with Michael D. Goldberg) of Beyond Mechanical Markets and Imperfect Knowledge Economics. Edmund S. Phelps, the winner of the 2006 Nobel Prize in Economics, is director of Columbia University's Center on Capitalism and Society. His many books include Structural Slumps and Seven Schools of Macroeconomic Thought.

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"The 1970 Phelps volume has been extremely influential in macroeconomics. Three of its contributors went on to win Nobel prizes for work detailed in the book, and it inspired many others who contributed to the small equilibrium models that became the workhorses of macroeconomics. Yet virtually all of these models use the assumption of rational expectations. In this new volume, Phelps and Roman Frydman assemble a new group of scholars to critique the work based on rational expectations. Phelps and Frydman argue that rational expectations destroyed one of the key premises of the original book--that independent expectations are critical for understanding macroeconomic phenomena. The contributors to this follow-up volume make a convincing case for the failure of several models with rational expectations, and present thought-provoking alternatives. Their efforts to build macroeconomic models without the rational expectations hypothesis might have the impact in their areas of research that the original volume had."--Christopher Pissarides, Nobel Laureate in Economics

"Microeconomic Foundations of Employment and Inflation Theory, edited by Edmund Phelps forty years ago, established the concept of 'micro foundations' as an essential macroeconomics idea. Later, 'rational expectations' was added as the second pillar of the current standard macro model. Recent events have challenged the validity of that model. This new Phelps volume, coedited with Roman Frydman, challenges and offers alternatives to the second pillar while retaining the first. It is a must-read for anyone interested in modern economic thought and its implications for policy."--Dale Mortsensen, Nobel Laureate in Economics

"A great volume."--Peter Howitt, Brown University

"This book brings together an exceptional group of economic theorists who discuss future avenues that the economics profession can take to replace the paradigm of rational expectations. The task is challenging and the outcome of the project still uncertain, but all the chapters are very interesting."--Fabrizio Coricelli, Paris School of Economics

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"The 1970 Phelps volume has been extremely influential in macroeconomics. Three of its contributors went on to win Nobel prizes for work detailed in the book, and it inspired many others who contributed to the small equilibrium models that became the workhorses of macroeconomics. Yet virtually all of these models use the assumption of rational expectations. In this new volume, Phelps and Roman Frydman assemble a new group of scholars to critique the work based on rational expectations. Phelps and Frydman argue that rational expectations destroyed one of the key premises of the original book--that independent expectations are critical for understanding macroeconomic phenomena. The contributors to this follow-up volume make a convincing case for the failure of several models with rational expectations, and present thought-provoking alternatives. Their efforts to build macroeconomic models without the rational expectations hypothesis might have the impact in their areas of research that the original volume had."--Christopher Pissarides, Nobel Laureate in Economics

"Microeconomic Foundations of Employment and Inflation Theory, edited by Edmund Phelps forty years ago, established the concept of 'micro foundations' as an essential macroeconomics idea. Later, 'rational expectations' was added as the second pillar of the current standard macro model. Recent events have challenged the validity of that model. This new Phelps volume, coedited with Roman Frydman, challenges and offers alternatives to the second pillar while retaining the first. It is a must-read for anyone interested in modern economic thought and its implications for policy."--Dale Mortsensen, Nobel Laureate in Economics

"A great volume."--Peter Howitt, Brown University

"This book brings together an exceptional group of economic theorists who discuss future avenues that the economics profession can take to replace the paradigm of rational expectations. The task is challenging and the outcome of the project still uncertain, but all the chapters are very interesting."--Fabrizio Coricelli, Paris School of Economics

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Rethinking Expectations

PRINCETON UNIVERSITY PRESS

Contents

Which Way Forward for Macroeconomics and Policy Analysis? Roman Frydman and Edmund S. Phelps...............................................11 Expectational Coordination Failures and Market Volatility Roger Guesnerie................................................................492 Learning as a Rational Foundation for Macroeconomics and Finance George W. Evans and Seppo Honkapohja....................................683 Keynes on Knowledge, Expectations, and Rationality Sheila Dow............................................................................1124 The Imperfect Knowledge Imperative in Modern Macroeconomics and Finance Theory Roman Frydman and Michael D. Goldberg.....................1305 Heterogeneous Gain Learning and Long Swings in Asset Prices Blake LeBaron................................................................1696 Opening Models of Asset Prices and Risk to Nonroutine Change Roman Frydman and Michael D. Goldberg.......................................2077 Animal Spirits, Persistent Unemployment, and the Belief Function Roger E. A. Farmer......................................................2518 Indeterminacies in Wage and Asset Price Expectations Edmund S. Phelps....................................................................2779 The Long Swings of Employment, Investment, and Asset Prices Gylfi Zoega..................................................................30110 Imperfect Knowledge, Asset Price Swings, and Structural Slumps Katarina Juselius........................................................32811 Stabilization Policies and Economic Growth Philippe Aghion and Enisse Kharroubi.........................................................35112 Swings and the Rules-Discretion Balance John B. Taylor..................................................................................37313 Principled Policymaking in an Uncertain World Michael Woodford..........................................................................389Contributors................................................................................................................................415Index.......................................................................................................................................421

Chapter One

Roger Guesnerie

1.1 Introduction

The stability of market economies has been a recurrent subject of debate since the beginning of the nineteenth century, which is usually viewed as the starting point of economics as a scientific field. "L'offre crée sa propre demande" ("supply creates its own demand"): this formula, a remarkable digest of the argument, is supposed to capture the essence of Jean Baptiste Say's analysis (1803). It expressed the basis for some of the early protagonists' strong confidence in the systemic stability of markets. But others strongly disagreed: Jean Baptiste Sismondi and the "catastrophist school"—and its most famous adept, Karl Marx—awaited the next crisis (possibly the final crisis) of the capitalist system. In the middle, Léon Walras thought that Say's argument was unconvincing but developed an alternative analysis that has long been viewed as supporting the optimists. The skepticism about market economies' systemic stability reappeared after the 1929 crisis, and Keynes forcefully argued for government intervention to counter markets' instability.

At the beginning of the current millennium, mainstream economic theory had apparently rallied to Say's optimism. Even if markets may not be fully self-regulating, our knowledge had improved, so that, according to Robert Lucas (2003), the "central problem of depression prevention has been solved." Was not the "great moderation" (see Bernanke 2008) proof of the adequacy and efficiency of the prevailing macroeconomic and monetary policies? But the argument reflected an appraisal of the facts that was intellectually and geographically biased (see Reinhardt and Rogoff 2008). Facts, such as crises and bubbles, are stubborn, and their stubbornness challenges the system of explanations that dominate contemporary economics. Neither the volatility of financial markets nor the logic of crises is satisfactorily explained by the best of our existing models.

Many economists, though not all, would agree that the recent crisis has raised questions about the state of economic theory; a subset would probably agree that reading the crisis through the standard lenses of the dominant approaches signals an outright failure of economic theory. Going somewhat further, I am among those who believe that economic theory has a key responsibility in the financial crisis that triggered recent economic events. The bottom line is that economists have provided an overly optimistic view of the workings of financial markets (many specialists' emphasis on the Efficient Market Hypothesis is a spectacular illustration of this bias). Such an overly optimistic view in the group of financial practitioners—a group already prone to self-satisfaction and reluctant to submit to regulation—triggered the deployment of uncontrolled imagination. Exaggeratedly sanguine conclusions, whether in finance or macroeconomics, reflected uncritical acceptance of modeling principles that, without justification, had become axioms. The question of what went wrong with standard economic theory in general and with its modeling principles in particular is, however, likely to suggest a variety of answers. Let me sketch three.

1. The first answer does not refer so much to modeling principles as to the diversification of modeling. There has been a multiplication of fronts in modern economic research, but progress on each front is increasingly obscure to outsiders, even those from neighboring subfields. I have argued elsewhere that the balkanization of knowledge is more of a problem in the study of economics (or social science more broadly), where social action must rely on all dimensions of understanding, than in a field like physics, where applications depend significantly on specifics. From my teaching experience, I have been struck by the fact that, in the field of finance, the communication between, say, the subfields of standard asset pricing, mathematical finance, "informational" finance, corporate finance, the econometrics of finance, and so forth, is surprisingly limited. Moreover, the difficulty of constructing a synthetic view of the different fronts is exacerbated by the question of systemic stability—not only of the financial system but also of the economy as a whole.

2. A second line of criticism concerns the rationality hypothesis, which has long been a quasi-obligatory ingredient of economic analysis. Real economic agents do not have the supposed rationality of Homo economicus. In fact, the rapid development of behavioral economics in the past 20 years has highlighted the limits of the standard concepts of rationality: behavior under uncertainty, time consistency, and symmetric treatment of losses and gains, to cite a few research themes, have been the subject of critical reconsideration. Hence the problem is not so much a failure to analyze the limits of the standard conception of rationality but rather a failure to focus on the consequences of this reconsideration in, say, finance and macroeconomics.

3. The failure of economic theory stressed here concerns...