| Testing for Neutrality and Rationality (2009) | |||||||||||||
Abstract | |||||||||||||
| The natural unemployment rate hypothesis made its first appearance as the provocative but somewhat vague statement that “in the long run ” a higher rate of inflation would not result in a lower unemployment rate, because agents ’ expectations would eventually adjust to eliminate any money illusions. Under the autoregressive or “adaptive ” expectations schemes initially used to fill it out, the natural rate hypothesis didn’t seem to pose any threat to conventional “activist ” Keynesian policy strategies incorporating feedback from past economic conditions to current policy settings. That was because “in the long run” could be taken to mean “in the distant future. ” A meaningful tradeoff between inflation and unemployment, one with an interesting dynamic structure, still existed under the natural rate hypothesis with adaptive expectations. The feedback rules that resulted from solving the dynamic optimization problem posed by that tradeoff were of the usual activist Keynesian form.t | |||||||||||||
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