SOVEREIGN EXPECTATIONS: Theory and History in the Financial Shocks and Crises of the 1970s and 1980s

The decades of the 1970s and 1980s witnessed significant upheavals in the international financial landscape, alongside notable advancements in economic expectation theory. Following the dissolution of the Bretton Woods system, a new era of financial instability emerged, coinciding with the growing prominence of rational expectations within economic discourse and policymaking. This chapter delves into the interaction between policymakers, financial sectors, and expectations during two pivotal financial episodes: Paul Volcker’s aggressive interest rate hikes in 1979 and the subsequent international debt crisis of 1982. Drawing from a synthesis of contemporary secondary sources, recent scholarship, and primary materials from key actors, this chapter explores the disconnect between the theoretical advancements in rational expectation literature and their application to these critical historical episodes. This analysis highlights the challenges faced by expectation theories in understanding historical processes and events and the complexities of economic expectations in practice.