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The Epidemiology of Macroeconomic Expectations

Christopher D. Carroll


Since the foundational work of Keynes (1936), macroeconomists have emphasized the importance of agents’ expectations in determining macroeconomic outcomes. Yet in recent decades macroeconomists have devoted almost no effort to modeling actual empirical expectations data, instead assuming all agents’ expectations are ‘rational.’ This paper takes up the challenge of modeling empirical household expectations data, and shows that a simple, standard model from epidemiology does a remarkably good job of explaining the deviations of household inflation and unemployment expectations from the ‘rational expectations’ benchmark. Furthermore, a microfoundations or ‘agent-based’ version of the model may be able to explain, in a way that still permits aggregation, stark rejections of the pure rational expectations framework like Souleles’s (2002) finding that members of different demographic groups have sharply different predictions for macroeconomic aggregates like the inflation rate.


Ever since the foundation of macroeconomic theory by John Maynard Keynes (1936), economists have understood that macroeconomic outcomes depend criticallyup on expectations about those outcomes. Keynes himself believed that in the short run, economies could experience booms and busts that reflected movements in the ‘animal spirits’ of business leaders (a view that has some appeal at the current moment of dot-com hangover), but the basis for most of today’s macro models was laid in the ‘rational expectations revolution’ of the 1970s. Led byLuc as, Sargent, Barro, and others, this approach made a set of assumptions that were much stronger than rationalityalone. In particular, the framework assumes that all agents in the economy are not merelyrational, but also share identical (correct) beliefs about the structure of the economy, and have instantaneous and costless access to all the latest economic data. Each agent combines these data with the true macroeconomic model to obtain a forecast for the future path of the economy, on the assumption that all other agents have identical beliefs and information (and therefore forecasts).

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