Rational Expectations Critiques of Keynesian Macromodels and Monetarist Models

Though RE [Rational Expectations] critiques have centered on Keynesian macromodels, monetarist models are also susceptible to these criticisms. An example using early formulations of the Natural Rate hypothesis illustrates both the general nature of the problem and its universality. In the past, Professor Milton Friedman and others have pictured economic agents as forming expectations adaptively, for example, forming expectations of future inflation rates on the basis of averages of past rates. As is now well known, this behavior would result in underestimation of the inflation rate when it is accelerating and overestimation when it is decelerating. Agents are thus being treated as biased or irrational in their expectations, as has been explained by Wallace.

--Gerald P. O'Driscoll Jr., "Rational Expectations, Politics, and Stagflation," in Time, Uncertainty, and Disequilibrium: Exploration of Austrian Themes, ed. Mario J. Rizzo (Lexington, MA: D.C. Heath and Company, 1979), 155-156.