Money in the utility function brocksidrauski model, cashinadvance model, shoppingtime model 4. Introduction to graduate macroeconomics peter thompson. This section contains as required a reading a short paper by sargent and wallace 1973, which uses cagans hyperinflation model to illustrate in a simple setting how the choice of expectations formation especially rational versus adaptive is critical. A critique of adaptive and rational expectations nikolay gertchev published online. Model and data cagans model posits that under conditions of severe inflation, movements in real money balances will be dominated principally by fluctuations in inflationary expectations. This paper also tests the hypothesis that monetary policy was implemented in aiming to maximize the inflation tax revenue. Blanc0 1978 or sargent 1979, versions of cagans model of portfolio balance during hyperinflations e. Following taylor 1991 and phylakis and taylor 1993, the model, omitting a constant term, can be written as.
Experimental evidence ramon marimon shyani sunder u ni versity of minnesota june, 1988 a preliminary report of this work was presented at the conference on learning from endogenous data, center for analytic economics. As demonstrated by hamilton and whiteman, the existence of bubbles and other extraneous influences can be detected only by verifying the difference in the order of integration. Many models in economics have been studied using the rational expectations idea. Cagans model of the german hyperinflation under the hypothesis that adaptive expectations are rational. While this model is known as an example of dynamics and market stability. Money demand, the cagan model, testing rational expectations. This section contains as required a reading a short paper by sargent and wallace 1973, which uses cagan s hyperinflation model to illustrate in a simple setting how the choice of expectations formation especially rational versus adaptive is critical. Following cagans pioneering study of the demand for money during hyperinflation cagan 1956, a number of researchers have reexamined cagans model and estimations under a variety of alternative assumptions concerning expectations formation, notably barro 1970, sargent and wallace 1973, frenkel 1975, sargent 1977, abel et. Assumptions about how people form expectations for the future shape the properties of any dynamic economic model. The demand for money during hyperinflations under rational. The second version, which is called the alternative version, builds on cagans model by considering that the semielasticity of the demand for money is a timevarying parameter. Di erence equations for economists1 preliminary and incomplete klaus neusser april 15, 2019 1 klaus neusser. Cagans model with rational expectations is formulated as an expectational difference equation whose solution is a rational expectations equilibrium. This lecture studies stability in the context of an elementary rational expectations model.
The moving wall represents the time period between the last issue available in jstor and the most recently published issue of a journal. Introducing the cagan type rational expectations model on complex discrete time domains. In another he considers a model termed mc by evans which like the one presented here is comprised of a version of cagans equation and an equation imposing rational expectations. Cagan published a study of hyper in ation episodes, episodes in which expectations seem to be crucial. Zimbabwes hyperinflation money demand model albert. A related work by tucci 2004 takes a step in this direction by restating cagans model using mperiod future expectations. That is, the public is assumed to form expectations of inflation according to 2, whereas the actual rate of inflation evolves according to. Cointegration and cagans model of hyperinflation under rational. Cagan type rational expectations model on time scales. As a model of expectation, the cobweb model of a market is familiar to practically all students of economics.
This problem is inspired from cagans model, but modi es the way expectations are modelled. Expectations and the learning approach princeton university. Cagans adaptive expectations formula delivers optimal forecasts. Economics 430 chris georges handout on rational expectations. Friedmans permanent income model of consumption smoothing. Expected inflation seems really central in hyperinflation. Rational expectations, hyperinflation, and the demand for. The theory of rational expectations re is a collection of assumptions regarding the manner in which economic agents exploit available information to form their expectations. Read this article to learn about the four theories of expectations formation in economic theory. In rare instances, a publisher has elected to have a zero moving wall, so their current issues are available. Thus, the rational expectations of future price levels resolve into rational expectations of future nominal money stocks.
This is a version of cagans model of hyperinflation 5 as studied by sargent and wallace 12. Sargent and wallaces unpleasant monetarist arithmetic, etc. Allowing for substitution between domestic and foreign assets 9. The demand for money during hyperinflation under rational expectations. I show that under this assumption, the natural unemployment rate hypothesis and a version of fishers. Sargent 1977 revisited cagans analysis, with a view towards explaining the discrepancy of the optimal and the actual in. Lecture 1 introduction to expectations and adaptive learning. Rational expectations, the real rate of interest, and the.
In a simple version of the cagan model of inflation, the demand for money depends. Second, notice that cagans model is one in which expectations are not necessarily assumed to be rational in the sense of muth 8. Salemi and sargent 1980 and sargent 1977j and rational expectations versions of friedmans permanent income theory of. Finally, the cagan model is estimated with the additional assumption of rational expectations for turkey for the considered period. Cagans model is capable of generating hyperinflation under two types of expectation mechanisms. They assumed that agents in the model were boundedly rational. It models the general price level as being determined by the. Money demand, the cagan model, testing rational expectations vs adaptive expectations. Cagans model by modelling the money supply process through the government budget constraint. The slope parameter in cagans portfolio balance equation is identified in some of these models and in others it is nota fact which clarifies results obtained in several recent papers.
It might be revealed to us in asset prices but, in a sense, this only pushes the question back one step one view is that people work hard to forecast the. Blanco 1978 or sargent 1979, versions of cagans model of portfolio balance during hyperinflations e. November 8, 2010 abstract this paper proposes a testing strategy for the null hypothesis that a multivariate linear rational expectations lre model has a unique stable solution determinacy against the. Master files room c525 imf working paper c 1991 international monetary fund. Consequently, so does the current equilibrium price level. Center for economic research university of minnesota. Rational expectations modeling has been the latest step in a very long line. Second, notice that cagan s model is one in which expectations are not necessarily assumed to be rational in the sense of muth 8. Rational expectations how should we think about peoples beliefs in reality. There is virtually no economic model that does not. Marcet and nicolini 2003 adopted a simple monetary model composed by a money demand equation, a government budget constraint and an exchange rate rule.
Cagans model for the demand of real money balances mp is. Obtaining the general solution of ctre model using the martingale approach. Money and inflation the cagan model of money and prices 2. We study a rational expectations version of philip cagans model linking the price level to the money supply cagan did not use a rational expectations version of his model, but sargent did we study this model because it is intrinsically interesting and also because it has a. Adaptive expectations, rational expectations, and money. Experimental evidence by ramon marimon and shyam under discussion paper no. As demonstrated by hamilton and whiteman, the existence of bubbles and other extraneous influences can be detected only by verifying the difference in the order of integration between the monetary. The first version is the original version of cagans model with rational expectations. Wallace and i sargent and wallace 1973 pointed out that under assumptions that make cagans adaptive expectations scheme equivalent with assuming rational expectations, cagans estimator of. Salemi and sargent 1980 and sargent 1977, and rational expectations versions of friedmans permanent income theory of consumption e. Cagan type rational expectation model on complex discrete time domains article in european journal of operational research 2371. In one case he too rejects the hypothesis that x, has the arima 0,1,1 implied by a model in which adaptive expectations are rational. Rational expectations version of cagans model of hyperinflation. Cagans model of hyperinflation under rational expectations.
We can use a very simple model of inflation due to cagan to examine this issue. This paper estimates the cagan type demand for money function for turkish economy during the period 1986. As demonstrated by hamilton and whiteman, the existence of bubbles and other extraneous influences can be detected only by verifying the. Introductory notes on rational expectations 1 overview. This paper proposes methods for estimating the demand schedule for money that cagan used in his famous study of hyperinflation 1956. On the other hand, it has theoretically been demonstrated that cagans model can be derived in an intertemporal utility maximizing framework under rational. The world is too complex for a model to possess both sound.
Particularly, should we expect, on theoretical grounds, that price in. In the present paper we provide a reexamination of the empirical evidence on cagans model under rational expectations for the case of the german hyperinflationary. This paper is an empirical study of the links between monetary variables and inflation based on cagans equation and its rational expectations solution, when the forcing variable is a fractionally integrated process. He is the father of the rational expectations revolution in economics, primarily due to his article rational expectations and the theory of price movements from 1961 muth earned his ph. Cointegration and cagans model of hyperinflation under rational expectations. Later on, in 1973 tom sargent and neil wallace introduced rational expectations into the cagans model. It shows that inference about the key money demand elasticity parameter, a, is very senstitive to the specification of the dynamic interaction of the unobserved money demand shock with prices and money.
Cagans model under rational expectations for the case of the german hyperinflationary period of the early 1920s, by applying recent contributions to the econometrics of nonstationarities. That is, the public is assumed to form expectations of inflation according to 2, whereas the actual rate of inflation evolves according to equation 5. The case of turkey article pdf available in empirical economics 243. On the other hand, it has theoretically been demonstrated that cagans model can be derived in an intertemporal utility maximizing framework under rational expectations and is therefore consistent with rational behavior kingston,1982. Nevertheless, cagans model approach is seriously challenged with the introduction of rational expectations when buiter 1987 shows that the model with perfect foresight is unable to produce any hyperinflation. From a technical viewpoint, the model studied here is interesting because it. Let m denote a countrys money supply and p its price level. This paper is an empirical study of the links between monetary variables and inflation based on cagan s equation and its rational expectations solution, when the forcing variable is a fractionally integrated process.
In another he considers a model termed mc by evans which like the one presented here is comprised of a version of cagan s equation and an equation imposing rational expectations. Discrete time february 9, 2012 1 classical model of the price level rational expectations hypothesis. The most familiar one among them is the rational expectations version of the cagans hyperinflation model where the expectation for tomorrow is formed using all. Unification and generalization of the existing cagan type rational expectations models in discrete time. Toulouse school of economics, 201220 problem set 6. In its stronger forms, re operates as a coordination device that permits the construction of a \representative agent having \representative expectations. The hyperinflation model of money demand or cagan revisited. Phillip cagans 1956 work on money demand in hyperinfiations. The cagan model is empirically tested using cointegration methodology. The german hyperinflation episode studied by cagan 3.
The key early applications of rational expectations will be studied later. Since the specified model is without any a priori assumption about expectations formation, we proceed with a test of the rational expectations hypothesis spelled out in a precise way below. Unobserved rational expectations and the german hyperinflation with endogenous money supply. This paper shows how to derive the family of models in which cagans model of hyperinflation is a rational expectations model. Imposing rational expectations exposed a lot about the granger causality structure between money and prices that prevailed during most of the hyperin. In a classic 1956 article, the chicago economist phillip cagan developed a simple model which does surprisingly well at accounting for the behavior of in. This paper estimates the cagan type demand for money function for turkish economy during the. Cagans paper posed and dealt with questions about the role of money in. Cagans rational expectation specication for the turk ish case. Reflections on rational expectations, journal of money. I show that under this assumption, the natural unemployment rate hypothesis and a version of fisher s theory about the interest rate and expected.
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