Asset prices, asset stocks and rational expectations

We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects limit the size of the policy rate response to inflation that is consistent with determinacy, so that inflation-targeting policies may not be capable of ensuring REE uniqueness. In this case it is advisable to combine policy rate responses to inflation with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and prevents expectations of higher inflation from becoming self-fulfilling.

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Which Way Forward for Macroeconomics and Policy Analysis?

Rethinking Expectations ◽

10.23943/princeton/9780691155234.003.0001 ◽

2013 ◽

Cited By ~ 2

Author(s):

Roman Frydman ◽

Edmund S. Phelps

Keyword(s):

Economic Analysis ◽

Policy Analysis ◽

Asset Prices ◽

Rational Expectations ◽

Market Volatility ◽

Natural Rate ◽

Expectations Hypothesis ◽

Natural Rate Of Unemployment ◽

Imperfect Knowledge

This introductory chapter discusses the papers presented at the Center on Capitalism and Society conference held in the fall of 2010. The conference, which commemorated the fortieth anniversary of the Phelps microfoundations volume, featured researchers engaged in developing alternatives to the Rational Expectations Hypothesis (REH). The Phelps volume provided radically new accounts of the comovements of macroeconomic aggregates, including inflation and unemployment, while casting serious doubt on the validity of policy analysis based on then-popular Keynesian macroeconometric models. This chapter considers the various efforts to reinvent macroeconomics that were discussed at the Phelps conference, with a particular focus on non-REH alternatives and their implications for economic analysis. Topics include nonroutine change and imperfect knowledge, expectational coordination and market volatility, autonomous expectations in long swings in asset prices, and the natural rate of unemployment.

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Transaction Risk, Derivative Assets, and Equilibrium

Quarterly Journal of Finance ◽

10.1142/s2010139216500014 ◽

2016 ◽

Vol 06 (01) ◽

pp. 1650001 ◽

Cited By ~ 1

Author(s):

H. Henry Cao ◽

Dongyan Ye

Keyword(s):

Asymmetric Information ◽

Social Welfare ◽

Private Information ◽

Asset Prices ◽

Rational Expectations ◽

State Variables ◽

Underlying Asset ◽

Market State

We describe a rational expectations model in which there is not only asymmetric information about payoffs but also asymmetric information about the preference, proportion and precision of private information of investors. We define this payoff-irrelevant risk as transaction risk, which is described by market state variables unrelated to payoffs. When derivative assets are introduced, the prices of the derivative assets can reveal information about transaction risk. Due to the informational role of derivative-asset prices, introducing derivative assets can increase social welfare and the price of the underlying asset even though no investors are trading in these derivative assets.

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