Living in an Imaginary World that Looks Real

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In the paper we show - using standard approaches, general equilibrium modeling and the assumption of complete rationality - that the macroeconomic environment is endogenous and is indeterminate. Speci fically, it is argued - without resorting to sunspot type arguments - that microeconomic fundamentals do not suffi ce to characterize the economy at the macro-level. In particular, we show how perceptions of rational agents of the workings of the economy a) shape the environment b) affect the environment su fficiently to ensure that rational economic agents fi nd the observed environment consistent with their beliefs even though it is not. As a by product, we illustrate that endogenous macro uncertainty can arise as an outcome if rational economic agents whose expectations are anchored on endogenous variables expect them to arise. Finally, we show that systematic errors can persist inde finitely under rationality.