Rational expectations and policy ineffectiveness : an econometric study of Taiwan

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This research investigates the rational expectations hypothesis and the proposition of policy ineffectiveness in the case of Taiwan. In addition to a preliminary and straightforward application of the typical neo-classical model to Taiwan, a small open economy counterpart of the Macro Rational Expectations (MRE) model is developed. The model embodies "new classical" characteristics: optimazing behavior, rational expectations, market-clearing, monetary neutrality and imperfect information. The methodology employed in estimation the model and testing of the joint hypotheses is an adjusted two-step procedure using Pagan's test statistics. The empirical work presented in this research uses extensively the approach of the "new econometrics", such as testing restrictions across and within the reduced form equations, and applying the innovation technique to determine the exogeneity of variables. Moreover, particular emphasis is given to sensitivity analysis. Generally, the empirical results indicate that the joint hypotheses of rational expectations and policy ineffectiveness are rejected over the sample period from 1963 to 1982. In order to interpret the non-neutrality property for the economy of Taiwan, two important alternative models - the "weak" version of the natural rate hypothesis and non-market-clearing rational expectations (NMC-RE) model are investigated. The testing results show that the non-neutrality property may depend upon the existence of the governmentbudget- constrained labor contract.

Rational expectations (Economic theory)