Assessing Rational Expectations: Sunspot Multiplicity and Economic Fluctuations

In this book Roger Guesnerie contributes to the critical assessment of the Rational Expectations hypothesis (REH). He focuses on the multiplicity question that arises in (infinite horizon) Rational Expectation models and considers the implications for a theory of endogenous fluctuations. The REH, which dominates the economic modeling of expectations in most fields of formalized economic theory, is often associated with an optimistic view of the working of the markets--a view that Guesnerie scrutinizes closely.The book is divided into four parts. The first part uses the framework of simple models to characterize the stochastic processes that trigger self-fulfilling prophecies and examines the connections between periodic equilibria (cycles) and stochastic equilibria (sunspots). (A sunspot is a random shock uncorrelated with underlying economic fundamentals.) The second part views sunspot equilibria as overreactions triggered by small variations of intrinsic variables--rather than as fluctuations with no trigger--and looks at the consequences for a monetary theory à la Lucas. The third part develops the basic theory to encompass more complex, multidimensional systems. It focuses in particular on the special class of equilibria generating small fluctuations around a steady state. Broadening the scope, the fourth part looks at the stability of cycles, sunspots in systems with memory, and current research on rational expectations.