ABSTRACT
This chapter shows that the underlying assumption of the rational-expectations hypothesis is that rational participants in a non-cooperative game immediately locate a Nash equilibrium. It presents a simple general equilibrium price-setting model under monopolistic competition. The chapter describes the problem of inflationary inertia, using the price-setting model. It discusses the role of income policies in anti-inflationary programs. The chapter also describes the potential for monetary reforms coupled with income policies and fiscal austerity in a package to fight a big inflation. Although empirically convincing, the explanation was soon eclipsed by the rational expectations revolution that dismissed backwardlooking inflationary expectations as an "ad hoc" assumption. The Keynesian inertia may appear as too rigid and too simplistic fifty years after the General Theory was published. Yet it reveals a formidable insight in a field that was only to be developed by von Neumann and Morgenstern almost ten years later, Game Theory.
