Nerding Out on Economics

I have moments where I nerd out pretty hardcore (I thrive on these moments!). Today’s moments: Thomas Sargent and Rational Expectations.  I’m not sure that my mind is wrapped entirely around the theory – I mean, nobel peace prize winning economics are a bit beyond my background. That said, this type of thing makes me want to go get a degree in econ.

So, the most straightforward explanation of the theory is from http://www.econlib.org/library/Enc/RationalExpectations.html:

He used the term to describe the many economic situations in which the outcome depends partly on what people expect to happen.

In recurrent situations the way the future unfolds from the past tends to be stable, and people adjust their forecasts to conform to this stable pattern.

The concept of rational expectations asserts that outcomes do not differ systematically (i.e., regularly or predictably) from what people expected them to be.

Rational expectations is a building block for the “random walk” or “efficient markets” theory of securities prices, the theory of the dynamics of hyperinflations, the “permanent income” and “life-cycle” theories of consumption, and the design of economic stabilization policies.

A great blog post by Tyler Cohen describing Thomas Sargent’s work: http://marginalrevolution.com/marginalrevolution/2011/10/thomas-sargent-nobel-laureate.html

Interview that is easier to understand for those non-economists: https://files.nyu.edu/ts43/public/personal/sargent_Mpls_interview.pdf

Why do I care? Because according to http://www.thegatewaypundit.com/2011/10/another-blow-to-obamanomics-2-anti-keynesians-win-nobel-prize-for-economics/:

Sargent’s discoveries in particular echo the rationale Republican leaders in Congress have presented in opposing the massive Democratic stimulus spending during the first two years of the Obama administration — that such spending seeks to give the economy nothing more than what House Budget Chairman Rep. Paul Ryan over the weekend aptly called a “sugar high.”

Hold up, Republican theories might be grounded in reality? *GASP* <– that’s an inflated reaction, I’m not really all that surprised. I’m not entirely sure on why or how tax cuts are any better or more informed than Keynesian policies (increased spending). All of this – this is great ammo for arguments on why Keynesian economics and increased spending don’t help the economy. I’ve yet to put in the time and energy to try to find similar arguments against tax cuts – I’m sure there are many. That said, I really enjoyed reading about this.

The best explanation of the nobel prize-winning theory and how that relates to our current financial situation are from this Forbes article, see below.

From http://www.forbes.com/sites/paulroderickgregory/2011/10/11/thomas-sargent-rational-expectations-and-the-keynesian-consensus/:

“The basic policy conclusion of the rational expectations hypothesis is that counter-cyclical monetary and fiscal policies affect real GDP and unemployment only if they are unanticipated. Even if households and businesses are caught off guard by the policy, output rises and unemployment falls only temporarily, until households and businesses adjust their expectations to the new reality. Sargent showed that expectations can adjust quite rapidly.

Rational expectations theory therefore implies that repeated counter-cyclical policies will be anticipated and are unlikely to affect real GDP or unemployment. The macroeconomy has a long-run equilibrium natural rate of unemployment and GDP from which unanticipated counter-cyclical policy can scarcely nudge the economy.

The Lucas-Sargent critique calls into serious question Keynesian discretionary policy. Those who devise stimulus programs must know in advance the extent to which households and businesses will correctly anticipate the policy. A policy that has been used x times in the past is unlikely to have a stimulative effect because it will be easily anticipated. Applying this notion to the present, it explains why Obama’s stimulus 1 had little effect if any and that any stimulus 2 will have even less effect.”

More on Thomas Sargent: https://files.nyu.edu/ts43/public/rational_expectations.html

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