Are New Classical Models Plausible Enough to Guide Policy?

Abstract

Rational Expectations and Other Elements of New Classical Macro Models The current renaissance of classical macroeconomics provides impressive new theoretical support for some old and strong propositions about economic mechanism and government policy. Rationality of expectations is one essential component of the new classical approach, methodologically the most interesting, insightful, and innovative. By itself, however, it does not lead to the strong propositions that excite the consumers, not just the producers, of economic theory. There are several other ingredients in the models that generate the dramatic conclusions I want to remind you of two of these at the outset; some other aspects of these models will come up in my comments on the individual papers. The two are the assumption of continuous market-clearing equilibrium and the specification of imperfections and asymmetries in the information on which economic agents act and form expectations. The two are connected in the sense that information gaps play in the new macroeconomics very much the same role that failures of prices to clear markets play in the Keynesian tradition, by which I mean the neoclassical synthesis reviewed in Lucas's paper. The market-clearing assumption is just that, an assumption. It is not justified by any new direct evidence that a Walrasian auctioneer process generates the prices observed from day to day or month to month or year to year, or by any new theory telling how separate Marshallian markets or administered prices yield Walrasian results. In one of his seminal articles, Robert Lucas introduces the assumption quite casually, saying:

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