Introduction by G.W. Evans and S. Honkapohja
The rational expectations hypothesis swept through macroeconomics during
the 1970’s and permanently altered the landscape. It remains the prevailing
paradigm in macroeconomics, and rational expectations is routinely used as the
standard solution concept in both theoretical and applied macroeconomic mod-
elling. The rational expectations hypothesis was initially formulated by John F.
Muth Jr. in the early 1960s. Together with Robert Lucas Jr., Thomas (Tom)
Sargent pioneered the rational expectations revolution in macroeconomics in the
1970s.
Possibly Sargent’s most important work in the early 1970’s focused on the
implications of rational expectations for empirical and econometric research.
His short 1971 paper “A Note on the Accelerationist Controversy” provided
a dramatic illustration of the implications of rational expectations by demon-
strating that the standard econometric test of the natural rate hypothesis was
invalid. This work was followed in short order by key papers that showed how
to conduct valid tests of central macroeconomic relationships under the ratio-
nal expectations hypothesis. Imposing rational expectations led to new forms
of restrictions, called “cross-equation restrictions,” which in turn required the
development of new econometric techniques for the study of macroeconomic
relations and models.
Tom’s contributions were wide ranging. His early econometric work in the
1970s includes studies of the natural rate of unemployment, the neutrality of
real interest rates with respect to money, dynamic labor demand, empirics of
hyperinflation, and tests for the neutrality of money in “classical” rational ex-
pectations models. In the 1980s Sargent (with Lars Hansen) developed new
econometric methods for estimating rational expectations models.
In addition to these seminal contributions to rational expectations economet-
rics, Sargent made several key contributions during this period to theoretical
macroeconomics, including the saddle path stability characterization of the ra-
tional expectations equilibrium and the policy ineffectiveness proposition (both
developed with Neil Wallace), and the observational equivalence of rational and
non-rational theories of monetary neutrality. In later work Tom continued to
extend the rational expectations equilibrium paradigm into new areas. Two
prominent examples are the implications of the government budget constraint
for inflation and “unpleasant monetarist arithmetic” (with Neil Wallace) and
the sources of the European unemployment problem (with Lars Ljungqvist).
Tom’s impact on macroeconomics in the early days of rational expectations
extends well beyond this research. His 1979 textbook Macroeconomic Theory
introduced a generation of graduate students around the world to a new vision of
macroeconomics in which time series analysis is fully integrated into macro the-
ory, and in which macroeconomic equilibrium is viewed as a stochastic process.
Sargent’s contributions have not been confined to the development and ap-
plication of the rational expectations paradigm. As a true scholar he became
interested in the theoretical foundations of rationality. As he describes below,
the initial criticisms of the concept of rational expectations led him in the 1980s