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Federal Reserve research paper kills another core New Keynesian idea about inflation expectations

The New York Times article (October 1, 2021, updated October 15, 2021) – Nobody Really Knows How the Economy Works. A Fed Paper Is the Latest Sign – reported on a paper by one Jeremy B. Rudd, who is a senior advisor in the Research and Statistics division at the Federal Reserve Bank in the US. The paper – Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?) – published as Finance and Economics Discussion Series 2021-062, by the Board of Governors of the Federal Reserve System, argues that a core aspect of New Keynesian macroeconomic orthodoxy “rests on extremely shaky foundations … and adhering to it uncritically could easily lead to serious policy errors.” The paper rejects the central notion in mainstream macro that the trajectory of inflation is driven by expectations. The idea that expectations are the key force has led central banks deliberately using the unemployed to fight an (imaginary) inflation threat. It has led fiscal authorities to pursue contractionary policies that have forced millions into unemployment. The Rudd paper is important because it shows the mainstream edifice is collapsing – it jettisons an other core concept. There is not much left in mainstream economics that hasn’t been rejected by evidence or exposed as being theoretically inconsistent.

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