The Engineering Tools That Shaped the Rational Expectations Revolution

Abstract

The rational expectations revolution was not based only on the introduction of Muth’s idea of rational expectations to macroeconomics; this introduction alone cannot explain the more drastic changes to the mathematical toolbox, concepts, and research strategies since the 1980s. The shift from “Keynesian economics” to “new classical economics” is based on a shift from a control engineering approach to an information engineering methodology. This “revolution” was even more radical; it also changed the epistemology and ontology of macroeconomics. The ontology of information engineering, and hence of new classical economics, is a world populated by machines that communicate by the exchange of noisy information. The decisions these machines make are conditioned on the (noisy) information they have about the current state of the world but which at the same time will affect future states. Policy in this world therefore means tracing an optimal trajectory taking all these issues into account. To show this shift in epistemology and ontology, the history of economics is interwoven with the history of mathematics, which cannot be detangled from the emergence of the digital computer. The computer changed the nature of mathematics in a specific way by adopting a new concept of solution, namely the algorithm.