Monday, June 17, 2013

Rational Expectations Theory Debunked in a Minute

Barry had this up on his blog over the weekend.  It is one of the best economic lectures I have ever seen.  Blyth is brilliant, funny and deeply irreverent.

The lecture is a little over 50 minutes and worth every minute of your time.

Here's his explanation of the the "confidence fairy" which is from the video starting at about 45 minutes.

This is the confidence fairy thing,

Imagine the economy is falling around your ears; you don’t know if you’re going to have a job tomorrow, your partner is already unemployed, you really don’t know about the future, but you really worry about the debt, you just lie awake all night worrying about the debt as people do,

So the government credibly signals that it’s going to massively cut government expenditures and what you do using your rational expectations that are built into your head – well you know the true structural form of the equation governing the economy and the value of the co-efficients therein – big assumption, but put that to one side – you calculate your lifetime budget and lifetime expenditures in relation to the fact that twenty years from now that because of these state spending cuts now you’ll pay less taxes then.  Thereby you can retrodect how much extra money you’ve got now and everybody goes to Ikea and buys a couch and that cures the recession. 

I am not making this shit up.