Knowledge that Transforms

In models where anticipations of future endogenous variables influence current behavior, there exists an infinity of solutions under the assumption of rational expectations. This problem has been dealt with, in the study of macro-economic models, by the implicit or explicit use of one of three additional requirements: optimality; consistency with alleged economic behavior; or conformity of the endogenous variables to an imposed stationarity condition. These requirements have coincided in existing models, leading to the choice of a unique solution, a forward solution. The purpose of this paper is to review the problem, characterize the solutions, and examine whether these requirements are acceptable. Section I presents a simple model and derives the set of solutions; the model makes no claim to generality, but has the major advantage that the issues are easily understood in this simple case. Section II discusses the requirement of consistency with economic behavior. Section III discusses the requirement of stationarity, and Section IV provides some conclusions.

This paper investigates the normative criteria that guide the allocation of a policy task to an elected politician versus an independent bureaucrat. The bureaucrat is preferable for technical tasks for which ability is more important than effort, or if there is great uncertainty about whether the policymaker has the required abilities. The optimal allocation of redistributive tasks is ambiguous, and depends on how the bureaucrat can be instructed. But irrespective of the normative conclusion, the politician prefers not to delegate redistributive policies.

This paper is based on a long-term research program with Rachel Kranton on the implications of identity for economic behavior.Our previous joint papers ( Akerlof and Kranton (2000), ( 2002) and ( 2005)) have explored implications outside of macroeconomics of utility functions dependent on people's notions of what ought to be.Some of this paper-especially Section IV ("Norms: The Missing Motivation") and Section X ("Economic Methodology")-has been directly taken from our joint manuscript: The Missing Motivation: Economics Made Human (Akerlof and Kranton (2006)).I am especially grateful to Professor Kranton for extending to me the invitation to join this project, after she had the initial insight in the spring of 1996 that concerns regarding identity were missing from economic theory.I have also benefitted from conversations with Robert Shiller, with whom I am co-authoring work on behavioral macroeconomics.

Most previous studies on intertemporal labor supply found very small or insignificant substitution effects. It is not clear, however, whether these results are due to institutional constraints on workers’ labor supply choices or whether the behavioral assumptions of the standard life cycle model with time separable preferences are empirically invalid. We conducted a randomized field experiment in a setting in which workers were free to choose their working times and their efforts during working time. We document a large positive wage elasticity of overall labor supply and an even larger wage elasticity of labor hours, which implies that the wage elasticity of effort per hour is negative. While the standard life cycle model cannot explain the negative effort elasticity, we show that a modified neoclassical model with preference spillovers across periods and a model with reference dependent, loss averse preferences are consistent with the evidence. With the help of a further experiment we can show that only loss averse individuals exhibit a significantly negative effort response to the wage increase and that the degree of loss aversion predicts the size of the negative effort response.

A long-run link between money and prices is evident for the United States since the Korean War if the M2 measure of money is used and the velocity of M2 (V2) is modeled as a mean-reverting series. This link between M2 and prices is the basis for a dynamic model of inflation that compares favorably in forecasting exercises with Phillips-curve and more typical monetarist approaches. The behavior of V2 is examined from 1870 to the present, providing a basis for reconsidering previous findings that V2 follows a random walk.