Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Robert Barro (born 1944)

Robert Barro, like Robert Lucas, is one of the intellectual heavyweights behind the rational expectations revolution (see the earlier section on ‘Robert

Lucas’).

Barro’s most famous work is in two areas:

His work with David Gordon built on Kydland and Prescott’s work (see the preceding section) on time inconsistency, which showed that discretionary monetary policy may lead to higher inflation than if policy makers follow rules. That is, discretionary monetary policy leads to an inflation bias.


Barro resurrected and built on much older work by David Ricardo to argue that rational individuals may act to offset completely changes in fiscal policy. For example, if the government increases spending by borrowing, rational individuals understand that this amount has to be paid back at some point by future taxes. Therefore, individuals save more today and consumption falls to offset the increase in government spending. This result is called Barro–Ricardian equivalence (or just Ricardian equivalence for short, sorry Robert!). We discuss this idea in more detail in Chapter 11.


Robert Hall (born 1943)

Consumption is the largest component of Gross Domestic Product (GDP; see Chapter 4), so it’s an important macroeconomic variable that economists have spent a lot of time trying to understand.

Robert Hall (yes, another Robert, what’s the deal?) had a revelation: rational expectations mean that trying to forecast what’s going to happen to consumption in the future is a mug’s game. Why? Well, when deciding how much to consume today, a far-sighted person with rational expectations should take into account all available information about her future income and circumstances. Only if she receives new information about the future should she change the amount that she consumes today.

But new information is by its very nature unpredictable – you can have good news (for example, you land a well-paid job) that should boost your consumption, or you can have bad news (you get skipped over for promotion) that should reduce your consumption.

Therefore, consumption should follow a random walk: it should be equally

likely to go up or go down and the best prediction for people’s consumption tomorrow is just their consumption today! Hall’s argument about why consumption should be unpredictable is very similar to the explanation provided by the Efficient Market Hypothesis regarding why asset prices should be unpredictable (see Chapter 16).