Rational Expectations (Sargent and Wallace)

“Rational” expectations, the optimal monetary instrument, and the optimal money supply rule by Thomas J. Sargent and Neil Wallace. Alternative monetary policies are analyzed in an ad hoc macroeconomic model in which the public’s expectations about prices are rational. The ad hoc model is one in which there is long-run neutrality, since it incorporates the aggregate supply schedule proposed by Lucas. Following Poole, the paper studies whether pegging the interest rate or pegging the money supply period by period minimizes an ad hoc quadratic loss function.