Finance and Economics Discussion Series (FEDS)
August 1998
Certainty Equivalence and the Non-Vertical Long Run Phillips Curve
Yvan Lengwiler
Abstract:
The certainty equivalence principle states that only the mean of a random variable is relevant to a decision maker facing uncertainty. This principle considerably simplifies the application of the idea of rational expectations considerably. Yet, certainty equivalence does not in general apply outside of the special case of the quadratic objective function subject to linear constraints. I use the standard augmented Phillips Curve to demonstrate the significant effects that occur with the breakdown of certainty equivalence.
Keywords: Rational expectations, expected utility maximization, certainty equivalence, Jensen's inequality, natural rate, long run Phillips Curve
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.