lecture5 - Lecture V Economics 202A Fall 2007 Section...

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1 Lecture V Economics 202A Fall 2007 Section sign-ups at end of class. Logs: for those of you who feel overworked (which is probably almost everybody) you may submit two , rather than three, logs over the next three weeks. We have now finished Lucas and Sargent. September 11: Taylor model September 13: 3 questionnaire articles: Kahneman et al, Shafir et al , Shiller September 18: Yellen and Shapiro and Stiglitz on Efficiency Wages September 20: no class September 25: Akerlof and Yellen on Near Rationality. September 27: Fehr and Tyran on experimental general equilibrium & Mankiw on menu costs. October 4: Akerlof on Irving Fisher on Head; Caballero, Engel & Haltiwanger on demand for ±durables.² October 9: Dornbusch on exchange rates This takes us to the next starred item on the reading list. I want to start where we ended last time, a bit more hurriedly than expected. I am going to give a very quick summary. There are two ingredients for Sargent³s result: First there are rational expectations. Because of these rational expectations the expected price level at time t, which Sargent calls t p* t-1 , mimics p t except for a white-noise error term. As a result the gap between actual inflation and expected inflation is just a white noise error term, , t . But then there is another assumption, which is the absence of money illusion. Because there is no money illusion, the Phillips curve depends critically on the difference between actual and expected inflation, plus another error term. This is equivalent to saying that the deviation from full employment depends on the gap between actual and expected inflation, plus this extra error term.
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2 As a result we find, robustly, no matter what we do, so long as we have such an aggregate supply equation, that the gap between actual and full employment is of the form: (, t + u t . So that is Sargent&s result. Looking at this formula tells us that there is no serial correlation of output. And there is no systematic effect of monetary policy. But there is a critical assumption here. In reality, aggregate supply may depend on the price level because there is some form of money illusion such as sticky money wages. If you believe that money wages may be sticky in some form or other, then you the monetary rule. The key assumption in his model then is the absence of money illusion. That is the beginning of today&s lecture. The most standard answer to rational expectations is the model by John Taylor. Taylor&s model is a model of rational expectations , but it also has money illusion of a natural sort. Lucas and Sargent emphasize rational expectations . But in fact their strongest assumption is probably the total
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This note was uploaded on 08/01/2008 for the course ECON 202A taught by Professor Akerlof during the Fall '07 term at University of California, Berkeley.

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lecture5 - Lecture V Economics 202A Fall 2007 Section...

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