in “classical rational” expectations

models. In the 1980s, Sargent

(with Lars Hansen) developed

new econometric methods for

estimating rational expectations

models.

In addition to these seminal

contributions to rational expecta-

tions econometrics, Sargent made

several key contributions during

this period to theoretical macro-

economics, including the saddle

path stability characterization of

the rational expectations equilib-

rium and the policy ineffectiveness

proposition (both developed with

Neil Wallace), and the observa-

tional equivalence of rational and

nonrational theories of monet-

ary neutrality. In later work Tom

Figure 14.2 Minnesota boundary

continued to extend the rational

waters, August 1974.

An Interview with Thomas J. Sargent 309

expectations equilibrium paradigm into new areas. Two prominent exam-

ples are the implications of the government budget constraint for in¬‚a-

tion and “unpleasant monetarist arithmetic” (with Neil Wallace) and the

sources of the European unemployment problem (with Lars Ljungqvist).

Tom™s impact on macroeconomics in the early days of rational expec-

tations extends well beyond this research. His 1979 textbook Macroeco-

nomic Theory introduced a generation of graduate students around the

world to a new vision of macroeconomics in which time-series analysis is

fully integrated into macro theory, and in which macroeconomic equilib-

rium is viewed as a stochastic process.

Sargent™s contributions have not been con¬ned to the development

and application of the rational expectations paradigm. As a true scholar,

he became interested in the theoretical foundations of rationality. As he

describes here, the initial criticisms of the concept of rational expecta-

tions led him in the 1980s to join a line of research called “learning

theory,” in which the theoretical underpinnings of rational expectations

were examined.

Tom became one of the pioneers in this area as well. His 1989

papers with Albert Marcet showed how to use the tools of stochastic

approximation to analyze convergence of least squares learning to rational

expectations equilibrium in a general framework. His 1993 book Bounded

Rationality in Macroeconomics helped to disseminate the learning approach

to a broader audience, and was

part of the rapid growth of re-

search on learning in the 1990s.

Tom™s 1999 book The Conquest

of American In¬‚ation called atten-

tion to the possibility of “escape

routes,” that is, occasional large

deviations from an equilibrium,

and led to a surge of interest

in persistent learning dynamics.

Closely related to the research on

learning are issues of robustness

and model misspeci¬cation to

which Tom (with Lars Hansen) has

recently made key contributions.

The depth and range of the

contributions we have listed is

huge, yet this is not the full extent.

Sargent also has done important

Figure 14.3 Hawaii, September

research in economic history. His

1980.

310 George W. Evans and Seppo Honkapohja

work in the 1980s on episodes of moderate and rapid in¬‚ations and the

recent research on monetary standards (with Fran§ois Velde) is much less

technical, but the rational expectations viewpoint remains clearly visible

in these works.

Many collaborators, researchers, and students have experienced Tom™s

remarkable intellectual depth and energy personally. His thinking is well

re¬‚ected in this interview, which has a somewhat unusual format. It gets

to the key issues very quickly. Only at the end is there commentary on

some of his personal experiences as a scholar.

Rational Expectations Econometrics

Evans and Honkapohja: How did you ¬rst get interested in rational

expectations?

Sargent: When I was a graduate student, estimating and interpret-

ing distributed lags topped the agenda of macroeconomists and other

applied economists. Because distributed lags are high-dimensional objects,

people like Solow, Jorgenson, Griliches, Nerlove, and Almon sought

economical ways to parameterize those distributions in clever ways; for

example, by using ratios of low-order polynomials in a lag operator. As

beautiful as they are, where on earth do those things come from? Cagan

and Friedman interpreted their adaptive expectations geometric distributed

lag as measuring people™s expectations. At Carnegie, Mike Lovell told me

to read John Muth™s 1960 JASA paper. It rationalized Friedman™s adap-

tive expectations model

for permanent income

by reverse engineering

a stochastic process for

income for which Cagan™s

expectation formula equals

a mathematical expecta-

tion of future values con-

ditioned on the in¬nite

history of past incomes.

Muth™s message was that

the stochastic process

being forecast should dict-

ate both the distributed

lag and the conditioning

variables that people use

Figure 14.4 With grandson Addison, January

to forecast the future. The

2005.

An Interview with Thomas J. Sargent 311

point about conditioning variables primed us to see the importance of

Granger“Wiener causality for macroeconomics.

Evans and Honkapohja: When did you ¬rst use rational expectations

to restrict a distributed lag or a vector autoregression in empirical work?

Sargent: In a 1971 paper on testing the natural unemployment rate

hypothesis. I ¬gured out the pertinent cross-equation restrictions and

showed that in general they didn™t imply the “sum-of-the-weights” test on

distributed lags that was being used to test the natural rate hypothesis.

That was easy because for that problem I could assume that in¬‚ation

was exogenous and use a univariate process for in¬‚ation. My 1973 and

1977 papers on rational expectations and hyperin¬‚ation tackled a more

dif¬cult problem. Those papers found the cross-equation restrictions on

a VAR for money and prices by reverse engineering a joint process for

which Cagan™s adaptive expectations formula delivers optimal forecasts.

This was worth doing because Cagan™s model ¬t the data so well. Impos-

ing rational expectations exposed a lot about the Granger causality struc-

ture between money and prices that prevailed during most of the

hyperin¬‚ations that Cagan had studied.

Evans and Honkapohja: Econometrically, what was the big deal about

rational expectations?

Sargent: Cross-equation restrictions and the disappearance of any free

parameters associated with expectations.

With Carolyn at Santorini, 2001.

Figure 14.5

312 George W. Evans and Seppo Honkapohja