Економічні науки/14. Економічна теорія

Marynenko N. Iu.

Ternopil Ivan Puluj national technical university

THE NEW CLASSICAL ECONOMICS AND ITS CRITICS

Rational-expectations macroeconomics (new classical economics) is a theory that assumes that the economy is characterized by rational expectations and that business cycles are due to incomplete information.

Rational expectations are expectations that are unbiased and based upon the best available information [1, p. 242]. Real business cycle theory assumes that business cycles are caused by changes in productivity – in particular, due to changes in technology and changes in technological knowledge.

The main features of the new classical economics are:

1. It accepts model of general equilibrium with no imperfections.

2. Prices are perfectly flexible, and all markets are permanently cleared (supply is equal to demand). All markets are self-correcting.

3. Individuals do not leave prices at “false” levels since this would result in disadvantages. Equilibrium is optimal.

4. Because present actions entail future consequences, all agents deliberately form rational expectations. That is, they exploit all available information at all times since it is in their best interests to do so.

5. Agents adjust their decisions and actions so that their plans will be fulfilled optimally when their expectations are correct.

6. Therefore, expectations (and information) play the dominant role in determining the state of the economy at any point in time.

7. They replace the deterministic setting with a stochastic one. People habitually suffer from expectational errors. These are the errors that explain economic fluctuations.

8. Fluctuations and unemployment can be traced to voluntary deviations of supply and demand.

9. Thus the business cycle is an equilibrium phenomenon, and is therefore optimal.

Today, most macroeconomic theorists, even if they call themselves monetarists or Keynesians, use rational-expectations theory. Therefore, current theory differs greatly from the models of the past. For example, most macroeconomic models of the 1950s and 1960s assumed people used an average of past inflation rates to predict what inflation will be. Consequently, in these models, the government can always fool people by increasing inflation above this average level. Believing that most people can be fooled in the same way year after year is difficult. Therefore, rational-expectations economists would reject this assumption. Similarly, they reject any model assuming people can be continually fooled or mistaken.

Critics of the theory of rational expectations rests on the following:

1. Expectations are not formed rationally. If expectations are rationally formed, using all the relevant information available, then forecasts of prices, interest rates, and output should be unbiased (with no systematic mistakes), efficient (use all past information), and consistent (forecasts should not conflict). The bottom line is that errors in forecasts should be unpredictable. If errors are predictable, then people are making systematic mistakes and not learning from them. Surveys of consumers and businesses show they make systematic errors in forecasts. This sort of evidence is not totally persuasive since what matters for the economy is people’s forecast about the prices and output that matter most to them and not what they think is happening to the whole economy. A more general criticism is that using all information may not be rational. Most people, for example, tie their shoes by habit without thinking about it. While we may not optimally tie our shoes every day, a good job is sufficient for most purposes. We all have various habits and rules of thumb. They save time so we can focus on more important tasks. Similarly, most business persons may find that focusing on running their businesses efficiently and using rules of thumb to set prices is more profitable than spending the time and money to get the best information possible about the economy.

2. Real changes may be needed, particularly in unemployment, to force people to change their expectations. Suppose the best forecasts predict that if workers do not lower their wages, unemployment will increase. Given the inaccuracy of forecasts, workers should rationally wait and see if unemployment does increase before they agree to a lower wage. Consequently, changes in aggregate demand, even if anticipated, may have real effects.

3. Because of multiyear contracts, workers may not be able to adjust fully to new information. Similarly, firms that do business with each other (for example, farmers, fertilizer makers, seed sellers, and tractor makers) may be better off adjusting their prices infrequently since their prosperity is linked to one another. Thus, institutional impediments may prevent making rapid adjustments even if people’s expectations are rationally formed.

4. Recessions cost too much and last too long to be rational. Recall that in rational-expectations models, people will spend money to predict and prepare for events. One response to this type of criticism is that recessions cost less than the output lost since more output can be produced later. A second response is that the government often causes the recessions, and predicting what the government is going to do is not just costly but impossible.

Literature

1. Walter J. Wessels. Economics. – 3rd ed. // Barron’s Educational Series, Inc., USA, 2000. – 593 p.