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The Sargent & Wallace Policy Ineffectiveness Proposition, Lucas Critique

The Sargent & Wallace Policy Ineffectiveness Proposition, Lucas Critique

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Published by hishamsauk

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Published by: hishamsauk on Mar 21, 2011
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12/16/2012

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M
ACROECONOMICS
: T
HE
S
ARGENT
& W 
ALLACE
P
OLICY
I
NEFFECTIVENESS
P
ROPOSITION
,L
UCAS
C
RITIQUE
 
P
OLICY
I
NEFFECTIVENESS
P
ROPOSITION
ASSUMPTIONS:
PRICE FLEXIBILITY
WAGE FLEXIBILITY
RATIONAL EXPECTATIONS
Assume the following model of an economy:
AD: 
t
= -b(y
t
² y
t-1
) + M
t
+ G +
t
SRAS: y
t
= y
t-1
+ a(t ² E
t-1
t
) + 
t
L
et us assume that G = 0 to simplify the algebra(the result also holds if we assume M = 0)
 
P
OLICY
I
NEFFECTIVENESS
P
ROPOSITION
)(11][1][)1)(( ][)()( ])([
1111111111
aababayyaaabyy aayyabyy yybayy
QQQQ
(!(! (! (!
Output isinfluencedby:
Output inthepreviousperiod
Something wecan·t make senseof ² 
WHAT is theExpected valueof inflation
?
Random shocks

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