monetary and fiscal policies in an open economy the central theme of this paper is that international linkages between national economies influence in fundamentally important ways the effectiveness and proper conduct of national macroeconomic policies specifically our purpose is to summarize the implications for the conduct of macroeconomic policies in open economies of both the traditional approach to open economy macroeconomics as developed largely by james meade robert mundell and j marcus fleming and of more recent developments our discussion is organized around three key linkages between national economies through commodity trade through capital mobility and through exchange of national monies these linkages have important implications concerning the effects of macroeconomic policies in open economies that differ from the effects of such policies in closed economies recent developments in the theory of macroeconomic policy have established conditions for the effectiveness of policies in influencing output and employment which emphasize the distinction between anticipated and unanticipated policy actions the importance of incomplete information and the consequences of contracts that fix nominal wages and prices over finite intervals in this paper we shall not analyze how these conditions are modified in an open economy however since our concern is with macro economic policy a principal objective of which is to influence output and employment we shall assume that requisite conditions for such influence are satisfied this abstract was borrowed from another version of this item

task assignment under agent loss aversion we analyze a task assignment model in which a principal assigns a task to one of two agents depending on future states if the agents have concave utility the principal assigns the task to them contingent on the state we show that if the agents are loss averse a state independent assignment assigning the task to a single agent in all states can be optimal even when the principal can write a contingent contract at no cost

financing constraints and reordering rules abstract constraints on external finance modify a simple inventory investment decision optimal policy is no action when cash holdings are less than threshold levels the control boundaries which are functions of the current level of inventories on the control boundaries additional cash is used for inventory replenishment when inventory holdings are below the level which would be held in the absence of financing constraints and for dividend payment when inventory holdings are equal to or exceed this level a fixed boundary at all inventory levels is used as an approximation to the fully optimal control allowing computation of the behaviour of aggregate inventory and cash holdings for a population of financially constrained firms there is a pronounced and extended dynamic response from inventory investment following aggregate disturbances to cash holdings to prices and to the standard error of the diffusion process for cash holdings this contrasts with the unconstrained case where such shocks have no effect on either inventory holdings or inventory investment

renegotiation proof climate agreements with full participation conditions for pareto efficiency recent contributions show that climate agreements with broad participation can be implemented as weakly renegotiation proof equilibria in simple models of greenhouse gas abatement where each country has a binary choice between cooperating i e abate emissions or defecting no abatement here we show that this result carries over to a model where countries have a continuum of emission choices indeed a pareto efficient climate agreement can always be implemented as a weakly renegotiation proof equilibrium for a sufficiently high discount factor this means that one need not trade off a narrow but deep treaty with a broad but shallow treaty

the short run demand for money a reconsideration the partial adjustment approach to the specification of the short run demand for money has dominated the literature for more than a decade there are three basic problems with this approach first the same lag structure is imposed on all variables and each independent variable enters only as a current value in contrast a rational individual would respond to different variables income interest rates prices with quite different lags second when the general price levelis subject to gradual adjustment hut can move quickly in response to supply shocks the influence of these supply shocks should enter with a negative sign third the estimated equation for real balances may not be a money demand equation at all but rather its coefficients may represent a shifting mixture of demand and supply responses the empirical work examines several alternative dynamic specifications including a generalized partial adjustment framework and the error correction model both of the latter specifications exhibit greater structural stability after 1973 than the standard partial adjustment specification and the generalized partial adjustment model also yields relatively small errors in post sample dynamic simulations shifts in coefficients as the sample period is extended after 1973 are consistent with the interpretation that the real balance equation no longer traces out structural demand parameters hut rather a mixture of demand and supply responses this abstract was borrowed from another version of this item

relative price variability and nonuniform inflationary expectations using a generalization of a rational partial information framework presented fully in cukierman and wachtel 1979 it is shown that there is a positive relationship between the variance of relative price change and the variance of inflationary expectations across markets in the economy this implication is then tested empirically using data on the variance of relative price change and on the variance of directly measured expectations the empirical evidence supports the view that there is a positive relationship between the two variances and that more than one third of this relationship is explainable in terms of the model presented

the abatement market a proposal for environmental cooperation among asymmetric countries we present a model of interaction among technologically asymmetriccountries whose use of an open access environmental resource generatesmutual externalities we show that countries can improve bothenvironmental quality and their individual welfare levels by buying sellingpollution abatement this market mechanism which reduces incentive forfree riding is more effective the larger the technological gap betweencountries

pay reference points and police performance several theories suggest that pay raises below a reference point will reduce job performance final offer arbitration for police unions provides a unique opportunity to examine these theories as the police officers either receive their requested wage or receive a lower one in the months after new jersey police officers lose in arbitration arrest rates and average sentence length decline and crime reports rise relative to when they win these declines in performance are larger when the awarded wage is further from the police union s demand the findings support the idea that considerations of fairness disappointment and more generally reference points affect workplace behavior

firm behaviour under the threat of liquidation abstract we study the optimal behaviour of a firm whose cash flow is determined by a diffusion process facing liquidation if internal cash balances fall below some threshold there is a conflict between the desire to pay dividends to satisfy shareholders and the need to retain cash as a barrier against possible liquidation stochastic optimal control characterises the value function and gives optimal decision rules for the firm the firm has a precautionary motive for retaining earnings the internal cost of funds and local risk aversion are both decreasing functions of cash held and in natural extensions to our model output and investment are both increasing functions of cash balances

modelling export prices and quantities in a small open economy volvement by u s manufacturing industry oxfjord economic papers 32 mar 1980 102 122 lindenberg eric b and stephen a ross tobin s q ratio and industrial organization journal of business 54 jan 1981 1 32 marvel howard p foreign trade and domestic competition economic inquiry 18 jan 1980 103 122 thomadakis stavros b a value based test of profitability and market structure this review 59 may 1977 179 185

loss aversion in a consumption savings model abstract we propose a model of consumption and saving based on kahneman and tversky s prospect theory that implies a fundamental asymmetry in consumption behavior inconsistent with other models of consumption when there is sufficient income uncertainty a person resists lowering consumption in response to bad news about future income this resistance is greater than the resistance to increasing consumption in response to good news we present empirical evidence from five countries that confirms this behavior

how do elections affect international cooperation evidence from environmental treaty participation is there a strategically beneficial time for political leaders to make international environmental commitments based on the political cycles theory we argue that leaders have incentives to delay costly ratification of international environmental agreements to the post electoral period however the cost of participating in these agreements is often lower for developing countries and they may enjoy indirect advantages which may make them more prone to ratifying in the pre electoral period these hypotheses are assessed empirically by studying the ratification process of 41 global environmental agreements censused in the environmental treaties and resources indicators database from 1976 to 1999 we use a duration model in which time is measured on a daily basis enabling us to precisely identify pre and post electoral periods a significant challenge in political cycles studies our investigation reveals the existence of political ratification cycles that are of substantial magnitude and non linear over the pre and post electoral years

departures from interest rate parity further evidence abstract daily data are used to test the theory of interest parity between the irish pound and three major currencies the tests are carried out within the context of a model suggested by pippenger 1978 and the statistical methodology used is spectral analysis the pippenger model emphasises the relaxation of two important implicit assumptions the exogeneity of the interest differential and the assumed infinitely elastic supply of arbitrage funds which have tended to characterise previous studies we attempt to reconcile our results which are generally supportive of interest parity with the exchange control arrangements currently in force in ireland

over optimism in forecasts by official budget agencies and its implications the paper studies forecasts of real growth rates and budget balances made by official government agencies among 33 countries in general the forecasts are found i to have a positive average bias ii to be more biased in booms and iii to be even more biased at the 3 year horizon than at shorter horizons this over optimism in official forecasts can help explain excessive budget deficits especially the failure to run surpluses during periods of high output if a boom is forecasted to last indefinitely retrenchment is treated as unnecessary many believe that better fiscal policy can be obtained by means of rules such as ceilings for the deficit or better yet the structural deficit but we also find iv countries subject to a budget rule in the form of euroland s stability and growth pact sgp make official forecasts of growth and budget deficits that are even more biased and more correlated with booms than do other countries this effect may help explain frequent violations of the sgp the question becomes how to overcome governments tendency to satisfy fiscal targets by wishful thinking rather than by action chile in 2000 created structural budget institutions that may have solved the problem independent expert panels insulated from political pressures are responsible for estimating the long run trends that determine whether a given deficit is deemed structural or cyclical the result is that chile s official forecasts of growth and the budget have not been overly optimistic even in booms unlike many countries in the north chile took advantage of the 2002 7 expansion to run budget surpluses and so was able to ease in the 2008 9 recession

how basic are behavioral biases evidence from capuchin monkey trading behavior behavioral economics has demonstrated systematic decision making biases in both lab and field data do these biases extend across contexts cultures or even species we investigate this question by introducing fiat currency and trade to a colony of capuchin monkeys and recovering their preferences over a range of goods and gambles we show that capuchins react rationally to both price and wealth shocks but display several hallmark biases when faced with gambles including reference dependence and loss aversion given our capuchins inexperience with money and trade these results suggest that loss aversion extends beyond humans and may be innate rather than learned

political institutions and pollution control this paper models the selection of environmental policies under authoritarian and democratic regimes and tests the hypothesis that political institutions systematically affect the enactment of environmental regulations the results support the contention that political institutional arrangements rather than resource endowments largely determine policies concerning environmental regulation copyright 1992 by mit press

are expectations of inflation rational or is variation of the expected real interest rate unpredictable abstract the joint hypothesis developed and tested in this paper is that the nominal interest rate is a rational expectation of the real interest rate plus the inflation rate and that variation of the expected real interest rate is unpredictable on the basis of information used in the test this test is applied to quarterly data on three month united states treasury bills of 1954 to 1973 the information used in the tests includes besides past interest rates and inflation rates past growth rates of the source base the money supply and real gnp some of the tests allow for a positive marginal tax rate which changes the results little the hypothesis is generally consistent with the data which provides support for the proposition that predictable changes of the money supply do not affect expected real interest rates over periods as short as a quarter

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

the timing of monetary and price changes and the international transmission of inflation this paper presents a theoretical and empirical investigation into timing relationships between variables within and across industrialized countries the main empirical results of our analysis are 1 domestic monetary expansion appears to lead inflation in the sense that money granger causes prices without feedback contradicting an implication of the monetary approach to the balance of payments 2 hardly any significant timing relationship exists between domestic and foreign rates of inflation during the fixed exchange rate period providing no evidence for a generalized law of one price 3 some sterilization of official reserve inflows was successfully performed by the non reserve central banks except for canada 4 u s interest rates granger cause foreign rates providing evidence of some international transmission via asset markets

the short run dynamics of prices and the balance of payments the purpose of this study is to analyze theoretically and empirically the short run behavior of prices and the balance of payments in a small open economy with a fixed exchange rate following the presentation of the theoretical framework the experience of mexico during 1950 73 is analyzed the model is based on what is known as the monetary approach to the balance of payments this approach as is frequently presented deals with long run equilibrium situations when all relative prices are fixed this long run equilibrium view was applied to test empirically the theory for several countries 2 using the assumption that there are no serious barriers to the international movement of capital and that all goods are traded 3 these assumptions imply that goods and capital markets are perfectly arbitraged and therefore that price levels and interest rates in all the countries always move together

inflation real returns and capital investment we find evidence for the hypothesis of mundell 1963 and tobin 1965 that the expected real return component of interest rates is negatively related to the expected inflation component in the mundell tobin model the variation in expected real returns is caused by the variation in expected inflation our evidence suggests however that the variation in expected real returns is more fundamentally an outcome of the capital expenditures process equilibrium expected real returns vary directly with capital expenditures in order to induce equilibrium allocations of resources between consumption and investment this positive relation between expected real returns and real activity which comes out of the real sector combines with a negative relation between expected inflation and real activity which is traced to the monetary sector thus inducing the negative relation between expected inflation and expected real returns predicted by mundell and tobin but explained in terms of a model much different from theirs

neoclassical theory versus prospect theory evidence from the marketplace several experimental studies have provided evidence that suggest indifference curves have a kink around the current endowment level these results which clearly contradict closely held economic doctrines have led some influential commentators to call for an entirely new economic paradigm to displace conventional neoclassical theory e g prospect theory which invokes psychological effects this paper pits neoclassical theory against prospect theory by investigating data drawn from more than 375 subjects actively participating in a well functioning marketplace the pattern of results suggests that prospect theory adequately organizes behavior among inexperienced consumers but consumers with intense market experience behave largely in accordance with neoclassical predictions moreover the data are consistent with the notion that consumers learn to overcome the endowment effect in situations beyond specific problems they have previously encountered this transference of behavior across domains has important implications in both a positive and normative sense

international environmental agreements and strategic voting two anonymous referees have provided very valuable comments and suggestions we have also benefited from discussions at seminars at the universities of bonn dortmund and dresden and at the conferences of euresco the european economic association and the verein fur socialpolitik this paper was partly written while haupt was visiting the economics department at the university of colorado at boulder he is very grateful to the members of the department particularly to eckhard janeba for their hospitality and for stimulating discussions and to the fritz thyssen stiftung for funding his research visit we also thank the deutsche forschungsgemeinschaft dfg for financial support

the international transmission of inflation to a small open economy under fixed exchange rates and highly interest sensitive capital flows an empirical analysis abstract this paper deals with the international transmission of inflation to a small open economy soe under fixed exchange rates and facing very interest sensitive capital flows it focuses particular attention on a channel of transmission which has been hitherto largely ignored namely portfolio capital flows arising from the monetary policy actions of the soe s reserve currency country rcc the bulk of the existing literature on this topic regards portfolio capital flows and money in general as having no causative role but simply passively mirroring transmission through commodity markets the model obtains strong support for ireland from 1972 to 1979 during which the ir was maintained in a strict one for one parity with the stg

the us market for so2 permits policy implications of the low price and trading volume abstract the price of so2 permits and the volume of trading under the us acid rain program have been lower than expected this can be explained by the creation and distribution of more permits than were initially authorized by the sale of permits by high cost abaters who are subject to more stringent local emission constraints or who have irreversibly invested in high cost abatement technologies and by the deregulation of the natural gas and railroad industries which in combination with incentives for cost cutting under the new market approach to so2 control has lowered marginal costs of abatement curves and made them more uniform across powerplants the low price of permits and low trading volume are evidence that market approaches to pollution control can be more cost effective than command and control regulations the effect of public policies and technological changes on the allowance market are usefully examined in the context of an ideal market in which the equilibrium price of allowances equals the marginal cost of abatement of individual powerplants using recent data from coggins and swinton 1996 we are able to explain the current price of permits with some accuracy

rational expectations and loss aversion potential output and welfare implications abstract we add some elements of prospect theory to an analytically tractable version of lucas s islands model and show that the inclusion of reference dependence declining sensitivity and loss aversion into the agents utility function leads to four main results first the presence of behavioral elements negatively affects the natural level of output second loss aversion reduces output variance third the expected utility of a representative agent is generally lower than that obtained when loss aversion is absent fourth the presence of loss aversion eliminates the paradoxical increase in expected utility that may be generated in the standard model by an increase in monetary policy uncertainty

money debt and prices in the united kingdom this paper is concerned with testing the asset theory of the price level using quarterly uk data over the period 1968 1979 expressed in its most general form the asset theory states that the aggregate price level p is related to real variables such as the level of economic activity y financial wealth and the composition of wealth in terms of financial assets such as money m government bonds b etc this theory has a long tradition and has been revived and developed by blinder and solow 1973 among many others for the present we limit our attention to only two financial assets namely money and government bonds although in principle this set could be enlarged this preoccupation reflects the attention paid to money and bonds in the literature and the requirement that financial assets should be of the outside variety which precludes bank lending corporate liabilities etc hence our general specification of the price level is

testing the exogeneity specification underlying the monetary approach to the balance of payments d espite the acute interest in the monetary approach to the balance of payments mbop over the past several years both as an explanation of the worldwide inflationary epidemic of the late 1960s and early 70s johnson 1972b and as a simple and manageable theoretical basis for policy recommendations by groups like the imf rhomberg and heller 1977 no general consensus has been reached as to the validity of the monetary model one reason for this is that the task of interpreting the results of the plethora of empirical tests of the monetary approach has been complicated by the controversy over the accuracy of the exogeneity assumptions underlying the mbop that are implicit in those studies these include the exogeneity with respect to reserve flows of the determinants of the demand for nominal money balances the domestic price level interest rate and level of real income as well as the domestic credit component of a country s money supply exogeneity makes the task of interpretation difficult for if the mbop assumptions regarding exogeneity are incorrect then to borrow geweke s 1978 p 163 words and to add studies in the mbop literature to which they would apply the otherwise identifying restrictions imposed on structural equations may not be sufficient to identify those equations argy and kouri 1974 genberg 1976 estimation procedures will be inconsistent e g bean 1976 zecher 1976 and the model cannot adequately portray the dynamics of the system it seeks to describe this last problem transcends any issue of estimation although it is not unrelated for it implies that the theoretical specification of the mbop is incorrect to begin with thus invalidating the putative reduced forms of the mbop that have come to represent the approach and form the basis for the policy recommendations alluded to earlier historically exogeneity was simply assumed as something not amenable to testing recently however geweke 1978 has demonstrated that the specification of exogeneity is a hypothesis with testable implications the purpose of this paper is to test formally the exogeneity hypothesis underlying empirical tests of the mbop specifically and the theoretical specification of the model in general using geweke s methods it is found that the hypothesis that the variables mentioned above are in fact exogenous can be rejected for each and every country in the sample this finding casts some doubt on the theoretical validity of the mbop and even more doubt on the accuracy of much of the empirical evidence garnered in its support the plan of the paper is as follows in section ii a mbop model is briefly presented and its exogeneity restrictions are highlighted in section iii the formal test of exogeneity is discussed and then in section iv the results of the tests using data from australia france germany norway and sweden are presented section v contains some conclusions

financial capacity and output fluctuations in an economy with multi period financial relationships this paper motivates a financial propagation mechanism in the context of an intertemporal production economy with asymmetric information and with borrowers and lenders who enter multi period financial relationships a key feature is that aggregate output and borrowers financial capacity the maximum overhang of past debt they may feasibly carry are determined jointly much in the spirit of gurley and shaw 1955 expectations of future economic conditions govern financial capacity which in turn may constrain current production especially in bad times a small but persistent shift in aggregate conditions may have a large impact on financial capacity making the framework capable of motivating large endogenous fluctuations in financial constraints understanding how small disturbances can induce large output fluctuations is an on going quest in macroeconomics this paper develops a simple framework in which shifts in aggregate economic fundamentals are amplified through their impact on financial conditions a distinguishing feature is that output and borrowers financial capacity the maximum overhang of past debt they may feasibly carry are determined jointly much in the spirit of gurley and shaw 1955 expectations of future economic conditions govern financial capacity and financial capacity may constrain current production especially in bad times a number of recent papers have resurrected the view that financial factors may play a part in propagating business fluctuations the underlying theories exploit the idea that with asymmetric information between borrowers and lenders agency costs may drive the price of uncollateralized external funds above the price of internal funds in this kind of setting a borrower s financial position is a key determinant of the terms of credit she faces in the aggregate swings in borrower balance sheets over the cycle amplify fluctuations in investment and output essentially by inducing counter cyclical movements in the required premium for external finance this simple mechanism is broadly consistent with informal descriptions of how financial and real variables interacted in the great depression bernanke 1983 and in the postwar business cycles eckstein and sinai 1986 in addition numerous recent panel data studies beginning with fazzari hubbard and peterson 1988 support the notion of a financial investment accelerator mechanism

exchange controls and interest rate determination with traded and non traded assets the irish united kingdom experience abstract this paper is an empirical study of the effectiveness of exchange controls in recent irish experience vis a vis the united kingdom specifically we examine the effects of domestic money market conditions on an array of irish interest rates following the imposition of the controls and the relative importance of covered british interest rates during the process of financial disintegration induced by these controls using time varying parameter estimation we find that the central bank gained only partial and temporary control over interest rates through domestic monetary channels for most assets and liabilities interest parity conditions were restored within six months after a policy change

trading rules and the environment does equal treatment lead to a cleaner world abstract in this paper we consider a three stage game in the context of a competing exporters model to compare and contrast the effects of discriminatory and uniform most favored nation mfn tariffs on countries choice over environmental standards for varying degrees of pollution spillovers because of the presence of punishment effects and stronger own and cross tariff effects we find that discrimination yields higher standards than mfn and free trade independently of the extent of pollution spillovers when pollution is local and incentives to free ride on other countries abatement efforts are weak we show however that welfare is larger under mfn than under discrimination in a dynamic setting we consider the impact of symmetric and asymmetric treatments on the sustainability of an international environmental agreement iea and obtain that multilateral cooperation is easier to sustain under discrimination than under mfn or free trade

two cheers and a qualm for behavioral environmental economics behavioral economics can gain more in roads into environmental economics if we better understand why exchange institutions fail more effectively reduce health risks and environmental conflicts encourage more coordination and cooperation design better incentive systems more accurately estimate economic measures of value and promote more protection at less cost behavioral economics deserves two cheers for advancing ideas of context dependence and social preferences which we illustrate with two examples of recent research

economic targets and loss aversion in international environmental cooperation in the standard emission problem each countryi s ruling party decides on an optimal level of emissions by analyzing the cost and benefit to the country however such policy decisions are often influenced by political partiesi incentives to be elected voters tend to give higher priority to economic issues than they do to environmental ones as a result political parties have additional incentives to reach a critical economic benefit level at a cost of higher emission level in order to satisfy votersi expectations in economic issues therefore this study explores the implications of political parties being averse to insufficient economic performance relative to a critical economic target level on sustaining an international environmental agreement on emission levels in doing so we allow countries to have asymmetric concerns about economic targets as well as asymmetric technology levels we find that stronger concerns about economic targets deter the most cooperative emission levels countries could jointly sustain furthermore technological asymmetry could either deepen or offset this impact these results suggest that efforts on achieving substantial international environmental agreements should be supported at the citizen level to eliminate the adverse effects

on delineating supply chain cash flow under collectionrisk abstract the credit terms for accounts receivable ar offered by sellers to buyers not only create a time lag between supply chain physical flow and cash flow but also increase the collection risk contributed by late collection and default previous studies describing the relationship between the two major supply chain flows did not consider the collection risk which poses a serious challenge to companies with limited cash resources when seeking growth opportunities in sales this study first delineates the relationship between the two flows during a growth period without imposing any constraints a stochastic optimization model is then developed to observe the managerial implications of cash flow risk under tight cash constraints

uncertainty loss aversion and markets for energy efficiency increasing energy efficiency is critical to mitigating greenhouse gas emissions from fossil fuel combustion reducing oil dependence and achieving a sustainable global energy system the tendency of markets to neglect apparently cost effective energy efficiency options has been called the efficiency gap or energy paradox the market for energy efficiency in new energy using durable goods however appears to have a bias that leads to undervaluation of future energy savings relative to their expected value this paper argues that the bias is chiefly produced by the combination of substantial uncertainty about the net value of future fuel savings and the loss aversion of typical consumers this framework relies on the theory of context dependent preferences the uncertainty loss aversion bias against energy efficiency is quantifiable making it potentially correctible by policy measures the welfare economics of such policies remains unresolved data on the costs of increased fuel economy of new passenger cars taken from a national research council study illustrate how an apparently cost effective increase in energy efficiency would be uninteresting to loss averse consumers

labor supply of new york city cabdrivers one day at a time life cycle models of labor supply predict a positive relationship between hours supplied and transitory changes in wages because such changes have virtually no effect on life cycle wealth previous attempts to test this hypothesis empirically with time series data have not been supportive estimated elasticities are typically negative or nonsignificant such analyses however are vulnerable to measurement error and other estimation problems we use data on daily observations of wages and hours for new york city cab drivers to estimate the supply response to transitory fluctuations in wages cab drivers decide daily how many hours to supply and face wages that are positively correlated within days but largely uncorrelated between days using these data our central finding is that wage elasticities are persistently negative from 5 to 1 in three different samples even after correcting for measurement error using instrumental variables these negative wage elasticities challenge the notion that cab drivers trade off labor and leisure at different points in time and question the empirical adequacy of life cycle formulations of labor supply

short term interest rates as predictors of inflation on testing the hypothesis that the real rate of interest is constant in an innovative and provocative paper in this review eugene fama presents evidence which appears to be consistent with the joint hypothesis that the real rate of interest ignoring taxes is a constant and that the market for u s treasury bills is efficient in the sense of embodying rational expectations those findings are strikingly at variance with a long list of previous studies which seemed to support the view that the real rate of interest varies over time and can be related to economic variables such as real output monetary policy and so forth 2 the methodologies which lead to these contradictory conclusions are quite different previous studies had followed the lead of irving fisher by relating nominal interest rates to distributed lags on past rates of inflation 3 these distributed lags are generally interpreted as approximations to the market s expected rate of inflation and thus any remaining variation is attributed to variation in the real rate 4 fama s methodology on the other hand draws on the fact that the difference between the market interest rate and the subsequently observed rate of inflation the ex post real interest rate consists by definition of the ex ante real interest rate plus a pure forecasting error 5 the hypothesis of market efficiency implies that these forecasting errors must be serially random thus observing ex post real rates is equivalent to observing ex ante real rates with random measurement error these errors of course confound the problem of identifying variation in the ex ante real rate in this paper we will argue that the relative magnitude of these measurement errors is such that the tests carried out by fama were not powerful enough to reject the joint hypothesis that the ex ante real rate is a constant and expectations are rational more powerful tests which are presented in this paper using the same data do lead to rejection of that hypothesis of course rejection