Rational Expectations in Macroeconomic Models

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It is commonly believed that macroeconomic models are not useful for policy analysis because they do not take proper account of agents’ expectations. Over the last decade, mainstream macroeconomic models in the UK and elsewhere have taken on board the Rational Expectations Revolution by explicitly incorporating expectations of the future. In principle, one can perform the same technical exercises on a forward expectations model as on a conventional model - and more. Rational Expectations in Macroeconomic Models deals with the numerical methods necessary to carry out policy analysis and forecasting with these models. These methods are often passed on by word of mouth or confined to obscure journals. This work brings them together with applications which are interesting in their own right. The specific subjects covered include: solving for model consistent expectations; the choice of terminal condition and time horizon; experimental design, ie the effect of temporary vs permanent, anticipated vs unanticipated shocks, deterministic vs stochastic, dynamic vs static simulation; the role of exchange rate; and optimal control and inflation-output tradeoffs. The models used are those of the Liverpool Research Group in Macroeconomics, the London Business School and the National Institute of Economic and Social Research.