Thomas J. Sargent

Rational Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule

Alternative monetary policies are analyzed in an ad hoc macroeconomic model in which the publics expectations about prices are rational. The ad hoc model is one in which there is long-run neutrality, since it incorporates the aggregate supply schedule proposed by Lucas. Following Poole, the paper studies whether pegging the interest rate or pegging the money supply period by period minimizes an ad hoc quadratic loss function. It turns out that the probility distribution of output--dispersion as well as mean--is independent of the particular deterministic money supply rule in effect, and that under an interest rate rule the price level is indeterminate.

Some Unpleasant Monetarist Arithmetic

Contrary to the conclusion of Sargent and Wallace, it is possible to exogenously and independently vary monetary and fiscal policy and retain steady-state equlibrium in economies like the United States. In particular,the central bank is not forced to monetize increased deficits either now or in the future. This conclusion is based on the fact that the real after-tax yield on government bonds is considerably less than the growth rate of real income except during brief disinflationary periods.In his presidential address to the American Economic Association (AEA), Milton Friedman (1968) warned not to expect too much from monetary policy. In particular, Friedman argued that monetary policy could not permanently influence the levels of real output, unemployment, or real rates of return on securities. However, Friedman did assert that a monetary authority could exert substantial control over the inflation rate, especially in the long run. The purpose of this paper is to argue that, even in an economy that satisfies monetarist assumptions, if monetary policy is interpreted as open market operations, then Friedman’s list of the things that monetary policy cannot permanently control may have to be expanded to include inflation.

Drifts and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S.

For a VAR with drifting coefficients and stochastic volatilities, the authors present posterior densities for several objects that are of interest for designing and evaluating monetary policy. These include measures of inflation persistence, the natural rate of unemployment, a core rate of inflation, and “activism coefficients�? for monetary policy rules. Their posteriors imply substantial variation of all of these objects for post WWII U.S. data. After adjusting for changes in volatility, persistence of inflation increases during the 1970s then falls in the 1980s and 1990s. Innovation variances change systematically, being substantially larger in the late 1970s than during other times. Measures of uncertainty about core inflation and the degree of persistence covary positively. The authors use their posterior distributions to evaluate the power of several tests that have been used to test the null of time-invariance of autoregressive coefficients of VARs against the alternative of time-varying coefficients. Except for one test, they find that those tests have low power against the form of time variation captured by our model. That one test also rejects time invariance in the data.

Formulating and estimating dynamic linear rational expectations models

This paper describes methods for conveniently formulating and estimating dynamic linear econometric models under the hypothesis of rational expectations. An econometrically convenient formula for the cross-equation rational expectations restrictions is derived. Models of error terms and the role of the concept of Granger causality in formulating rational expectations models are both discussed. Tests of hypothesis of strict econometric exogeneity along the lines of Sim’s are compared with a test that is related to Wu’s.

Estimation of Dynamic Labor Demand Schedules under Rational Expectations

A dynamic linear demand schedule for labor is estimated and tested. The hypothesis of rational expectations and assumptions about the orders of the Markov processes governing technology impose overidentifying restrictions on a vector autoregression for straight-time employment, overtime employment, and the real wage. The model is estimated by the full-information maximum-likelihood method. The model is used as a vehicle for reexamining some of the paradoxical cyclical behavior of real wages described in the famous Dunlop-Tarshis-Keynes exchange.

Rational expectations and the theory of economic policy

There is no longer any serious debate about whether monetary policy should be conducted according to rules or discretion. Quite appropriately, it is widely agreed that monetary policy should obey a rule, that is, a schedule expressing the setting of the monetary authority’s instrument (e.g., the money supply) as a function of all the information it has received up through the current moment. Such a rule has the happy characteristic that in any given set of circumstances, the optimal setting for policy is unique. If by remote chance, the same circumstances should prevail at two different dates, the appropriate settings for monetary policy would be identical.

Optimal taxation without state-contingent debt

In an economy studied by Lucas and Stokey, tax rates inherit the serial correlation structure of government expenditures, belying Barros earlier result that taxes should be a random walk for any stochastic process of government expenditures. To recover a version of Barros random walk tax-smoothing outcome, we modify Lucas and Stokeys economy to permit only risk-free debt. Having only risk-free debt confronts the Ramsey planner with additional constraints on equilibrium allocations beyond one imposed by Lucas and Stokeys assumption of complete markets. The Ramsey outcome blends features of Barros model with Lucas and Stokeys. In our model, the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in Lucas and Stokeys model, but incomplete markets put a near-unit root component into government debt and taxes, an outcome like Barros. However, we show that without ad hoc limits on the governments asset holdings, outcomes can diverge in important ways from Barros. Our results use and extend recent advances in the consumption-smoothing literature.

Money as a medium of exchange in an economy with artificially intelligent agents

Abstract We study the exchange economies of Kiyotaki and Wright (1989) in which agents must use a commodity or fiat money as a medium of exchange if trade is to occur. Our agents are artificially intelligent and are modeled as using classifier systems to make decisions. In the assignment of credit within the classifier systems, we introduce some innovations designed to study sequential decision problems in a multi-agent environment. For most economies that we have simulated, trading and consumption patterns converge to a stationary Nash equilibrium even if agents start with random rules. In economies with multiple equilibria, the only equilibrium that emerges in our simulations is the one in which goods with low storage costs play the role of medium of exchange (i.e., the ‘fundamental equilibrium’ of Kiyotaki and Wright).

Rational expectations and econometric practice

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Evolving Post-World War II U.S. Inflation Dynamics

For postwar U.S. data, this paper uses Bayesian methods to account for the four sources of uncertainty in a random coefficients vector autoregression for inflation, unemployment, and an interest rate. We use the model to assemble evidence about the evolution of measures of the persistence of inflation, prospective long-horizon forecasts (means) of inflation and unemployment, statistics for testing an approximation to the natural-unemployment-rate hypothesis, and a version of the Taylor rule. We relate these measures to stories that interpret the conquest of U.S. inflation under Volcker and Greenspan as reflecting how the monetary policy authority came to learn an approximate version of the natural-unemployment-rate hypothesis. We study Taylors warning that defects in that approximation may cause the monetary authority to forget the natural-rate hypothesis as the persistence of inflation attenuates.