CHAPTER 13 - Non-Walrasian Prices and Perfect Foresight

Abstract

The new classical economics claim that the results of traditional Keynesian-type macroeconomics, notably those results about effectiveness of economic policy, are due only to expectational errors by economic agents. For the adepts of this school, who generally use models described as rational expectations models, perfect foresight would be sufficient to make economic policies almost completely ineffective. A number of authors in the Keynesian tradition have stated that the primary reason of government policy being ineffective in the so-called rational expectations models is not so much the assumption about expectations, but rather the assumption of general market clearing, which is quite commonly made by the new classicals. This chapter describes a simple non-Walrasian equilibrium model where all errors in expectations are excluded, as perfect foresight is assumed in both price and quantities. In this model, economic policies have no effect on activity if the economy is at the Walrasian equilibrium, but such is not the case if non-Walrasian equilibria are considered. The effectiveness of each policy then depends on the regime that the economy is in.