Assessing Rational Expectations 2: Eductive Stability in Economics

A theoretical assessment of the Rational Expectations Hypothesis through subjecting a collection of economic models to an eductive stability test.

The rational expectations hypothesis (REH) dominates economic modeling in areas ranging from monetary theory, macroeconomics, and general equilibrium to finance. In this book, Roger Guesnerie continues the critical analysis of the REH begun in his Assessing Rational Expectations: Sunspot Multiplicity and Economic Fluctuations, which dealt with the questions raised by multiplicity and its implications for a theory of endogenous fluctuations. This second volume emphasizes eductive learning: relying on careful reasoning, agents must deduce what other agents guess, a process that differs from the standard evolutionary learning experience in which agents make decisions about the future based on past experiences. A broad eductive stability test is proposed that includes common knowledge and results in a unique rationalizable expectations equilibrium. This test provides the basis for Guesnerie's theoretical assessment of the plausibility of the REH's expectational coordination, emphasizing, for different categories of economic models, conditions for the REH's success or failure.

Guesnerie begins by presenting the concepts and methods of the eductive stability analysis in selected partial equilibrium models. He then explores to what extent general equilibrium strategic complementarities interfere with partial equilibrium considerations in the formation of stable expectations. Guesnerie next examines two issues relating to eductive stability in financial market models, speculation and asymmetric price information. The dynamic settings of an infinite horizon model are then taken up, and particular standard and generalized saddle-path solutions are scrutinized. Guesnerie concludes with a review of general questions and some cautious remarks on the policy implications of his analysis.

Roger Guesnerie is Professor at the Collège de France and President of the Paris School of Economics. He is the author of Assessing Rational Expectations and Assessing Rational Expectations 2 (MIT Press, 2001, 2005).