Pigou on expectations and the cycle

This note draws attention to Pigou’s treatment of rational expectations and the ‘surprise’ supply function. In modern terminology he argued that: 1

equilibrium and rationality implied the absence of systematic forecasting errors,

2

monetary factors could independently affect output only by means of unan- ticipated inflation (deflation). But that:

3

asymmetrical errors due to ‘psychological causes’ could be a separate source of fluctuations and, what is more, could be set up in response to the monetary factors in 2.