The Conquest of American Inflation

by Sargent, Thomas J.

• ISBN13: 9780691090122
• ISBN10: 0691090122
• Edition: Reprint
• Format: Paperback
• Copyright: 2001-11-12
• Publisher: Princeton Univ Pr

Summary

In the past fifteen years, inflation has been conquered by many advanced countries. History reveals, however, that it has been conquered before and returned. InThe Conquest of American Inflation,Thomas J. Sargent presents a groundbreaking analysis of the rise and fall of U.S. inflation after 1960. He examines two broad explanations for the behavior of inflation and unemployment in this period: the natural-rate hypothesis joined to the Lucas critique and a more traditional econometric policy evaluation modified to include adaptive expectations and learning. His purpose is not only to determine which is the better account, but also to codify for the benefit of the next generation the economic forces that cause inflation. Sargent begins with an explanation of how American policymakers increased inflation in the early 1960s by following erroneous assumptions about the exploitability of the Phillips curve--the inverse relationship between inflation and unemployment. In subsequent chapters, he connects a sequence of ideas--self-confirming equilibria, least-squares and other adaptive or recursive learning algorithms, convergence of least-squares learners with self-confirming equilibria, and recurrent dynamics along escape routes from self-confirming equilibria. Sargent synthesizes results from macroeconomics, game theory, control theory, and other fields to extend both adaptive expectations and rational expectations theory, and he compellingly describes postwar inflation in terms of drifting coefficients. He interprets his results in favor of adaptive expectations as the relevant mechanism affecting inflation policy. Providing an original methodological link between theoretical and policy economics, this book will engender much debate and become an indispensable text for academics, graduate students, and professional economists.

Author Biography

Thomas J. Sargent is Donald Lucas Professor of Economics, Stanford University, and Senior Fellow at the Hoover Institution at Stanford

Table of Contents

Preface	xiii
The Rise and Fall of U.S. Inflation	1	(13)
Facts	1	(1)
Two interpretations	1	(5)
The triumph of natural-rate theory	2	(1)
The vindication of econometric policy evaluation	3	(3)
Readers's guide	6	(5)
The Lucas critique	6	(1)
Time-consistency and credible plans	6	(1)
Adaptive expectations and the Phelps problem	7	(1)
Equilibrium under misspecification	7	(1)
Two types of self-confirming equilibria	8	(1)
Adaptive expectations	9	(2)
Empirical vindication	11	(1)
Raw and filtered Data	11	(3)
Demographic Adjustment and drift	13	(1)
Ignoring The Lucas Critique	14	(6)
The Lucas critique	14	(3)
Outline	14	(1)
The appeal to drifting coefficients	15	(1)
A loose end	16	(1)
Parameter drift as point of departure	17	(1)
Relevance of the Critique	17	(2)
Rational expectations models	19	(1)
The Credibility Problem	20	(11)
Introduction	20	(1)
One-period economy	20	(8)
Least squares learning converges to Nash	25	(2)
More foresight	27	(1)
Appendix on stochastic approximation	28	(3)
Credible Government Policies	31	(19)
Perfection	31	(7)
Historical antecedents	33	(2)
The method of Abreu-Pearce-Stacchetti	35	(3)
Examples of recursive SPE	38	(10)
Infinite repetition of Nash outcome	39	(1)
Infinite repetition of a better-then-Nash outcome	39	(2)
Something worse: a stick and carrot strategy	41	(1)
The worst SPE	42	(2)
Multiplicity	44	(1)
Attaining the worst, method 1	45	(1)
Attaining the Worst, method 2	45	(1)
Attaining the worst, method 3	46	(1)
Numerical examples	46	(2)
Interpretations	48	(2)
Remedies	49	(1)
Adaptive Expectations (1950's)	50	(9)
Adaptive expectations	50	(3)
The original Phelps problem	50	(3)
Phelps problem: general version	53	(6)
Testing the natural-rate hypothesis	55	(2)
Disappearance of beliefs as state variable	57	(1)
Subversion of Phelps's Model	57	(2)
Optimal Misspecified Beliefs	59	(9)
Equilibrium with mistakes	59	(1)
An experiment in Bray's lab	60	(7)
Misspecification	62	(5)
Lessons	67	(1)
Self-Confirming Equilibria	68	(19)
Two literatures	68	(1)
Directions of fit	68	(1)
Imperfect (1970's) rational expectations equilibria	69	(1)
Self-confirming equilibria	69	(5)
Objects in Phelps problem	69	(1)
Elements of self-confirming models	70	(1)
The actual Phillips curve	70	(1)
Self-confirmation	71	(1)
Direction of minimization	72	(1)
Vanishing parameters	73	(1)
Self-confirmation under classical direction	74	(1)
Moment formulas	74	(1)
Keynesian direction of fith	75	(6)
Government beliefs and behavior	75	(1)
Calculation of S	76	(1)
Special case by hand	77	(2)
Why not Ramsey?	79	(1)
Direction of minimization: caution	80	(1)
Equilibrium computation	80	(1)
Messages	81	(1)
Equilibrium with misspecified beliefs	81	(6)
An erroneous forecasting function	82	(2)
Approaching Ramsey	84	(2)
Grounds for optimism	86	(1)
Adaptive Expectations (1990's)	87	(35)
Least squares adaptation	87	(1)
Primer on recursive algorithms	88	(7)
Iteration	89	(1)
Stochastic approximations	90	(1)
Mean dynamics	90	(1)
Constant gain	91	(1)
Escape routes	92	(1)
Simplification of action functional	93	(1)
From computation to adaptation	94	(1)
Adaptation with the classical identification	95	(6)
The government's beliefs and behavior	95	(1)
RLS and the Kalman filter	96	(1)
Private sector beliefs	97	(1)
System evolution	98	(1)
Mean dynamics	98	(1)
Stochastic approximation	99	(2)
Adaptation with Keynesian identification	101	(1)
Government beliefs and behavior	101	(1)
Technical details	102	(1)
Simulations	102	(12)
Classical adaptive simulations	103	(7)
Relation to equilibria under forecast misspecification	110	(1)
Simulation with Keynesian adaptation	111	(3)
Role of discount factor	114	(1)
Conclusions	114	(1)
Appendix A: RLS and the Kalman filter	115	(4)
The Kalman filter	115	(1)
Recursive least squares	116	(1)
Matching RLS to the Kalman filter	117	(1)
Initial conditions for simulations	118	(1)
Appendix B: Anticipated utility	119	(3)
Boiler plate recursive rational expectations model	119	(1)
Anticipated utility model	120	(2)
Econometric Policy Evaluation	122	(8)
Introduction	122	(1)
Likelihood function	122	(2)
Estimates	124	(3)
Interpretation	127	(1)
Appendix on likelihood function	128	(2)
Triumph or Vindication?	130	(5)
Expectations and the Lucas critique	130	(3)
Reservations	133	(2)
Glossary	135	(2)
References	137	(8)
Author Index	145	(2)
Subject Index	147