The Theory of Inflation Expectations on Trial
The concept of expectations has, arguably, been the crown jewel of contemporary macroeconomics. In itself, it represents roughly half of all so-called “micro-foundations” innovations that distinguishes modern macroeconomics from its Keynesian origins. Incorporated into economic modelling beginning with the 1970s, it is the theory of expectations more than anything else that basically lays the foundation for modern-day central bank policy which – until a decade or so ago – seemed to have finally mastered the ups and downs of the economy. Inflation targeting, policy guidance, transparency, commitment, credibility, time consistency and so on are just another way of saying the successful central banks manage the economy by managing expectations. Thoughts are future actions and words can shape reality before it even comes into being, altering 19th century style classical causality – this is in a nutshell the Sci-Fi appeal and semiotic charm of a concept that undergirds current economic theory! Recent economic events has put the theory of expectations to the test like never before, but the outcomes are far from satisfactory. More
