As the Nobel laureate economist Christopher A. Sims observed in 2003, in the past, it was assumed that economic agents are not only rational, but also computationally unconstrained. But the truth is that people have limited information-processing capacity, so, as the German phenomenologist Edmund Husserl noted, our brains select information to set aside unprocessed. Our behavior – rational or not – is shaped not by all available information, but only by the information to which we pay attention.

During Volcker’s Fed tenure, people were acutely aware of the costs of double-digit inflation, so they would notice and respond – even overreact – to any development that seemed remotely likely to spur inflation. As today’s economic actors set their expectations, they may well be paying attention to very different kinds of developments. Given the powerful role of expectations in determining economic outcomes, this could be enough to alter the functioning of the business cycle.

Economists such as Paul Krugman and Kiminori Matsuyama argue that there are two types of macroeconomic equilibria: one where information is anchored to history, and another where it is anchored to rational expectations about the future. Understanding how economic actors determine which information to process or neglect could go a long way toward revealing the relative importance of history and expectations in determining equilibria, thereby helping policymakers to avoid costly imbalances. Volcker would surely approve of that.

Koichi Hamada is professor emeritus at Yale University and a special advisor to Japanese Prime Minister Shinzo Abe.

‚Äč©Project Syndicate

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