The Conquest of American Inflation

by Thomas J. Sargent

Overview

In the past fifteen years, inflation has been conquered by many advanced countries. History reveals, however, that it has been conquered before and returned. In The 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.

Product Details

ISBN-13:	9780691090122
Publisher:	Princeton University Press
Publication date:	12/02/2001
Edition description:	Reprint
Pages:	168
Product dimensions:	6.00(w) x 9.25(h) x (d)

About the Author

Thomas J. Sargent is Donald Lucas Professor of Economics, Stanford University, and Senior Fellow at the Hoover Institution at Stanford. He is the author of many articles and books on macroeconomic theory, most recentlyBounded Rationality in Macroeconomics.

Table of Contents

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

What People are Saying About This

Robert King

The Conquest of American Inflation is a fascinating document, marshalling sophisticated economic theory and econometrics to the task of explaining the past 50 years of U.S. monetary policy and its interaction with macroconomic activity. It will surely be widely cited and widely discussed.
— Robert King, University of Virginia

Cooley

A very deep and very subtle piece of scholarship.... Sargent is most impressive in his ability to bring theoretical arguments to bear on the problem of distinguishing empirically between the two histories of postwar inflation.
— Thomas F. Cooley, University of Rochester

David Kreps

A fascinating study of a real-world phenomenon that uses ideas from recent theoretical work on bounded rationality. Brilliant and pathbreaking.
— David Kreps, Stanford University

From the Publisher

"A brilliant technical treatise that includes both new results and original synthesis. . . . The Conquest of American Inflation may help to fashion a new paradigm in macroeconomic analysis."—Ben Bernanke, Princeton University

"A very deep and very subtle piece of scholarship.... Sargent is most impressive in his ability to bring theoretical arguments to bear on the problem of distinguishing empirically between the two histories of postwar inflation."—Thomas F. Cooley, University of Rochester

"The Conquest of American Inflation is a fascinating document, marshalling sophisticated economic theory and econometrics to the task of explaining the past 50 years of U.S. monetary policy and its interaction with macroconomic activity. It will surely be widely cited and widely discussed."—Robert King, University of Virginia

"A fascinating study of a real-world phenomenon that uses ideas from recent theoretical work on bounded rationality. Brilliant and pathbreaking."—David Kreps, Stanford University

Ben Bernanke

A brilliant technical treatise that includes both new results and original synthesis. . . . The Conquest of American Inflation may help to fashion a new paradigm in macroeconomic analysis.
— Ben Bernanke, Princeton University

Editorial Reviews

Thomas J. Sargent, Winner of the 2011 Nobel Prize in Economics

From the Publisher

A path-breaking contribution. It shows new ways to analyze dynamic economics. It is a basic reference to understand—and develop—dynamic macroeconomic theory in the 21st century.

Journal of Economic Literature - Ramon Marimon

A lucid, penetrating inquiry into the 'ifs and buts' of rational expectations and their implications for policy. . . . This book illustrates Sargent's great curiosity and honesty . . . A beautifully crafted, deep, and . . . very accessible work. . . . It deserves to be one of the century's most influential books on macroeconomics.

The Times Higher Education Supplement - Peter Sinclair

A path-breaking contribution. It shows new ways to analyze dynamic economics. It is a basic reference to understand—and develop—dynamic macroeconomic theory in the 21st century.
— Ramon Marimon

Journal of Economic Literature

A lucid, penetrating inquiry into the 'ifs and buts' of rational expectations and their implications for policy. . . . This book illustrates Sargent's great curiosity and honesty . . . A beautifully crafted, deep, and . . . very accessible work. . . . It deserves to be one of the century's most influential books on macroeconomics.
— Peter Sinclair

Times Literary Supplement

This book illustrates Sargent's great curiosity and honesty. . . . [Here] the reader gets a lucid, penetrating inquiry into the "ifs and buts" of rational expectations (RE) and their implications for policy.
— Peter Sinclair

The Times Higher Education Supplement

Sargent (economics, Stanford U.) provides analysis of the rise and fall of US inflation after 1960, focusing on 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. Annotation c. Book News, Inc., Portland, OR (booknew.com)

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