SOUNDS...: RATIONAL GROWTH EXPECTATIONS....

Thursday, December 7, 2017

JOURNAL OF ECONOMIC THEORY 7, 53-65 (1974)

Uniqueness of the Price Level in

Monetary Growth Models with Rational

FISCHER BLACK*

Graduate School of Business, Uhevsity of Chicago, Chicago, Illinois 60637

Received September 11, 1972

INTRODUCTION

Almost every model of a monetary economy assumes that individuals

and firms behave irrationally. They buy and sell goods at prices other than

equilibrium prices, or they count the money the government gives them as

wealth but ignore the fact that everyone else is getting money Tao, or they

continue to expect zero inflation when the rate of inflation has been increasing

for several periods. Monetary growth models1 have moved in the

direction of assuming rational behavior, but they have generally continued

to assume that expectations about the rate of inflation are formed in an

irrational manner. Following Cagan [4], they typically assume some form

of adaptive expectations, even when some other rule for revising expectations

would give more accurate results.

In a model that does not include uncertainty in some explicit form, a

straightforward way to put in rational expectations is to assume that

individuals and firms have perfect foresight. One can then look at the set

of paths for all economic variables such that each individual is maximizing

his utility and each firm is maximizing its value, at every point in time, in

the light of the current and future values of all the variables. Each such

path is a “competitive equilibrium” consistent with rational economic

behavior.2

In a world with well-developed financial markets, it is not easy to

describe a mechanism by which changes in monetary policy or changes in

the money supply itself will lead to changes in the price Level or rate of

* I am grateful to William Brock, Stanley Fischer, Milton Friedman, Arthur Laffer,

Merton Miller, David Ranson, Thomas Sargent, Charles Upton, and a referee for ideas

SOUNDS...