Rational Expectations, the Lucas Critique and the Optimal Control of Macroeconomic Models: A Historical Analysis of Basic Developments in the 20th Century

In this paper, we first consider the role of rational expectations, the Lucas critique and the policy ineffectiveness debate in economic applications of optimal control theory. The problem of time-inconsistency in optimal control of macro-economic models with rational expectations will then be analyzed. The impact of reputation and the stochastic environment on the problem of inconsistency in dynamic choice together with the question of how can the developments in optimal control of macroeconomic models with forward-looking expectations contribute to the practice of econometric model building are the other topics which are discussed. We have adopted a historical approach in this paper, and the scope of our analysis is confined to the basic contributions made in the 20th Century.