On the Policy Ineffectiveness Hypothesis

While the policy-ineffectiveness proposition has been widely debated, its validity and relevance can be defended on methodological grounds. To do so, one has to realize its conditional character. For new classicals, countercyclical stimulation of aggregate demand through monetary policy instruments is neither possible nor beneficial if the assumptions of the theory hold. If expectations are rational and if markets are characterized by completely flexible nominal quantities and if shocks are unforeseeable white noises, then macroeconomic systems can deviate from the equilibrium level only under contingencies (i.e. random shocks). However, no systematic countercyclical monetary policy can be built on these conditions. Even monetary policy makers cannot foresee these disturbances hitting economies, so no planned response to such shocks is possible.

According to the common and traditional judgement, new classical macroeconomics brought the inefficiency of economic policy to the fore. Moreover, these statements are always undermined by the fact that new classical assumptions are too far from life-world conditions to plausibly underlie the theorems. So, it has to be realized that the precise design of the assumptions underlying the policy-ineffectiveness proposition makes the most influential, though highly ignored and misunderstood scientific development of new classical macroeconomics.

New classicals have never asserted that activist economic policy (in a narrow sense: monetary policy) is ineffective. Lucas and his followers have drawn the attention to the conditions under which this inefficiency probably emerges.

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An Introduction to the Lucas Papers

In the following weeks my purpose of primary importance is to form a coherent view on the Lucas Papers held at Rubenstein Library, Duke University. I have the photocopies of all the relevant boxes and folders, so the work can start now. A huge amount of unpublished drafts, notes and letters.

Of course, I have a pre-given (i.e. previously formed) idea as to the papers and a unique view from which I will try to approach the drafts. This is methodology. For me Lucas is a realist economist, so I am interested in finding some details that can help us to get to know him as a scientist committed to understanding socio-economic reality. It is shocking how much ignorance contemporary mainstream economics is forced to face today. The key to clarifying the subtle relationship between mainstream models and reality is to be found in the works of Lucas I strongly believe. One cannot hope to have an in-depth understanding of, say, the grounding principles of RBC-theory without understanding the methodology of new classical macroeconomics.

So for a while I will keep posting on the Lucas Papers. This is the forum where I will share my early thoughts and conjectures.

Inflation Tarageting and Mainstream

New classical macroeconomics and rational expectations hypothesis can be applied to give account of how and why inflation targeting works. As it is well known, expectations of firms (or, accurately, the subjective probability distribution of outcomes) will be distributed around the prediction of the theory itself (in other words, the objective probability distribution of those outcomes) for the same information set. So, rational agents expect an outcome the emergence of which is the most probable. However, the success of specifying the relevant model is limited, and the full and perfect knowledge of a given macroeconomic system can be regarded as a comfortable presumption at best. Knowledge of the relevant model is not feasible, even if high-level econometrical techniques are accessible or an adequate identification of the relevant explanatory variables is performed. So, the biasedness of estimations is not independent of the quantity and quality of information to which the modeller has access. In other words, estimations are asymptotically unbiased with respect to the exploited information.

Consistency can be interpreted similarly. On the basis of asymptotical unbiasedness, a moderated version of the rational expectations hypothesis can be suggested in which familiarity with the theoretical parameters is not a requirement for the relevant model. An agent (e.g. the central bank) with access to information along with high-level methodological skills, which are satisfactory in quantitative and qualitative terms alike, will be able to specify a quasi-relevant model (by increasing the quantity of information processed it will be capable of reducing biasedness) describing a specific macroeconomic system, and the more focal its position, the stronger the likelihood to make other agents accept it. Agents will decide to adjust their expectations to the outputs of the (quasi) relevant model. In this way, individual expectations become unbiased as much as possible, albeit against a background of considerable passivity. According to some researches, this is the theoretical background of the functionality of inflation targeting regimes.

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Getting Mentioned… On Bookforum.com…?! Yes!

I am feeling distinguished now. “Omnivore” section of U.S. Bookforum.com mentioned my latest draft “Reassessing Contemporary Macroeconomics on Methodological Grounds” right on the front page. Omnivore has just published a compilation on papers and books written about some recent problems in economics and it was the occasion on which my draft was mentioned. This citation directed a lot of readers to the draft. Happiness!

Bookforum was founded in 1994 as a print magazin published five times a year. It has a website updated on a daily basis. The public views on Bookforum seem to be favourable…

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