Question

One of the proposals coming from Republican congressmen and senators in 2010 is the idea that the Federal Reserve should dramatically increase the transparency of monetary policy. The idea is for the Fed to explain exactly what it intends to do concerning interest rates and then do it. The FOMC announcement about the direction of monetary policy is couched in vague words, called “Fedspeak,” that are subject to different interpretations. Suppose that the Fed was required to be completely transparent in its policy decisions using precise language and then was required to actually implement the policy unambiguously.

If the rational expectations model has validity, what would happen to the speed at which the economy adjusts correctly to changes in monetary policy?

Answer 1

According to the rational expectations model, outcomes of economic policies do not differ predictably from what people expected them to be.

Its application helps us understand why some economic policies work and why some of them do not work.

If rational expectations model is supposed to be valid, the economy would immediately ajust itself correctly to changes in monetary policy as people would have already expected the policy changes to have desired impact.