Macroeconomic Analysis Without the Rational Expectations Hypothesis

Abstract

The article presents a temporary equilibrium framework for macroeconomic analysis that allows for a wide range of possible specifications of expectations but reduces to a standard new Keynesian model in the limiting case of rational expectations. This common framework is then used to contrast the assumptions and implications of several different ways of relaxing the assumption of rational expectations. As an illustration of the method, the implications of alternative assumptions for the selection of a monetary policy rule are discussed. Other issues treated include the conditions required for Ricardian equivalence and for existence of a deflation trap.