Support for rational expectations models with U.S. data

Abstract

This paper compares simplified versions of three macroeconomic models: the Income-Expenditure model, the St. Louis model, and the Rational Expectations model. Nominal income and inflation rate reduced form equations that nest all three theories are fitted to U.S. quarterly data for period 1951: 4 to 1980: 2. Tests of exclusion restrictions indicate that: (1) Potential output affects the inflation rate but not nominal income. (2) non-stationary parameters characterize the inflation equation but not the nominal income equation, (3) Money affects the inflation rate quicker during periods characterized by volatile money growth rates and by low values of Lucas π parameter. These findings suggest that the Rational Expectations model best describes the data.