Rational Expectations of Government Policy: An Application of Newcomb's Problem

A robust resolution of Newcomb’s paradox

“…No performance data on repeated versions of the game or alternative justification of the superior being's predictive abilities are required other than the ability to determine the equilibrium of a game, which is then realized based on rational expectations (Muth 1961) on the part of the agent and the being. Frydman et al (1982) and Broome (1989) point out that the problem of a government committing to a policy which tries to implement measures contingent on agents' actions taken under the policy may be akin to Newcomb's problem. Indeed, when the agents anticipate the implemented policy measures, their actions may tend to undo the effect of these measures.…”

“…As a result, assuming rational expectations on the part of the agents, the best the government can do is to obtain inflation, corresponding to the third-best outcome. As Frydman et al (1982) point out, this dilemma relates to a problem discussed in a seminal paper by Kydland and Prescott (1977) where a government seeks to find an optimal dynamic policy. Because it cannot commit to its future actions, any time-consistent policy [which it has an incentive to adhere to at any future time; see Weber (2011), p. 191] is suboptimal compared to what could be achieved with full commitment, when agents believe that the initially announced policy remains unchanged.…”

The alleged necessity of microfoundations

“…In an interesting article Frydman, O'Driscoll, and Schotter (1982) apply the so-called Newcomb's paradox to a case in which a monetary authority must make a decision in a situation in which its payoff is affected by whether or not its action is predicted by the public. They show that if the public has good predictive powers, a unique rational decision of the monetary authority may not exist.…”

“…In this matrix U(Mn, ML), for example, is the von Neumann-Morgenstern utility of the monetary authority related to the situation in which the public expects ML and the authority chooses MH. Following Frydman, O'Driscoll, and Schotter (1982)…”

Equilibrium, interest and money: three essays in the history of economic theory

“…Thus, by this argument the asset market equilibrium configuration implied by the own-rates structure is "built up" from a sophisticated the idea of rational expectations has come back to this point (Frydman, 1982;Frydman et al, 1982). Interestingly for us, the focus has been on the possible instability of a rational expectations equilibrium in Its resemblance to the "Holmes-Moriarlty problem," which Is formally the same problem as Keynes' famous beauty contest (see O'Drlscoll and Rlzzo, 1985, pp.…”