Rational expectations theory implies fiscal policy is neutralized when agents anticipate it

Evidence

According to this new view, the Keynesian instruction sheet must, in some sense, see individuals as being deluded all the time by government policy; otherwise, they would see the policy coming and anticipate it in their decisions, thus cancelling out its effects on real variables—so-called expectations or “Ricardian equivalence” effects. For example, if I know that the Democrats like to spend money, and that the money they like to spend is my taxes, I will change my spending decisions in advance of the Democrats coming to power to protect my money. Thus, if individuals do invest in being correct, as this new theory suggested, then chronically error-prone individuals would be eliminated from the market, which creates a world in which all the players in the market share the same true model of the economy. Consequently, government can’t do much at all except screw things up by getting in the way. Left alone with common and accurate information, such individuals’ expectations about possible future states of the economy will converge and promote a stable and self-enforcing equilibrium. — Mark Blyth, Austerity, 126

Categorization

• DEFINE: Explains Ricardian equivalence and rational expectations as the mechanism by which fiscal policy cancels itself out; anchors the justification for austerity.
• XREF: Directly serves the reading purpose of connecting to Mattei and austerity critique literature, since Ricardian equivalence underwrites expansionary austerity claims. — connects to: Expectations-based expansionary austerity theory rests on Denmark and Ireland cases — Mark Blyth, Austerity: The History of a Dangerous…, 457; The ECB justified austerity through rational-expectations Ricardian consumer theory — Mark Blyth, Austerity: The History of a Dangerous…, 174; Postwar economists treated money as redistributionally neutral, echoing Hume’s view — Mark Blyth, Austerity: The History of a Dangerous…, 386

Broader Connections

• The ECB justified austerity through rational-expectations Ricardian consumer theory #expands (0.82) — Mark Blyth, Austerity, 174
• Expectations-based expansionary austerity theory rests on Denmark and Ireland cases #complicates (0.72) — Mark Blyth, Austerity, 457