Sargent on Rational Expectations: Revolutionizing Macroeconomics
The Rational Expectations Revolution: A Conversation with Thomas Sargent
Did you know that the way we think about monetary policy today is a direct result of the work done by economists like Thomas Sargent in the 1970s? Let's dive into his interview with Art Rolnick and explore how rational expectations theory has reshaped macroeconomics.
The Vocabulary of Rational Expectations
Thomas Sargent, along with colleagues at the University of Minnesota, fundamentally changed macroeconomic theory by introducing the concept of 'rational expectations.' This theory assumes that individuals behave strategically, anticipating future policy actions and adjusting their behavior accordingly. In other words, people are not passive actors but strategic players who look to the future and act in ways they believe will improve their lives.
In our dynamic and uncertain world, our beliefs about what others will do play big roles in shaping our behavior, observes Sargent. This perspective demanded deeper analysis and more sophisticated mathematics, leading to precise econometric methods to test and refine rational expectations theory.
Modern Macroeconomics Under Attack
Post-2007 financial crisis, modern macroeconomics, including rational expectations theory, has come under scrutiny. Critics argue that it relies too heavily on mathematical models, assumes market efficiency, and ignores unemployment and frictions. However, Sargent maintains that these criticisms are misguided.
Modern macro has not failed, argues Sargent. It was developed to understand the dynamic and uncertain world we live in. He believes that the tools of modern macro, especially rational expectations theorizing, can shed light on financial crises.
Portfolio Implications: Banks, Inflation, and Unemployment
So, what does this mean for our portfolios? Let's consider some assets:
- iShares 20+ Year Treasury Bond (TLT): Rational expectations theory suggests that people anticipate policy changes. Therefore, any surprises in monetary policy could lead to bond price fluctuations. - Citigroup (C), Goldman Sachs (GS), Bank of America (BAC): Banks operate in a dynamic environment where people's beliefs about future policies shape their behavior. Understanding these dynamics can help manage risk exposure. - Microsoft (MS): As a tech giant, MS operates in an industry less affected by monetary policy changes. However, rational expectations theory can guide its strategic decisions based on anticipated market trends.
Actionable Insights
Investors should:
1. Factor in people's anticipation of future policies when assessing asset prices. 2. Consider the strategic behavior of individuals and institutions when analyzing risks and opportunities.*