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Living in an Imaginary World that is Real

In the paper we show – using standard approaches, general equilibrium modeling and the assumption of complete rationality – that macroeconomic environment is endogenous and is indeterminate. Specifically, it is argued – without resorting to sunspot type arguments – that microeconomic fundamentals do not suffice to characterize the economy at the macro level. In particular, we show how rational perceptions of the workings of the economy a) shape the environment b) affect the environment sufficiently to ensure that rational economic agents find the environment consistent with their beliefs even though it is not. As a by product we illustrate that endogenous fluctuations can arise as an outcome if rational economic agents whose expectations are anchored on endogenous variables expect them to arise. Furthermore, our results cast doubt on the current macroeconomic methodological approach and in the strongest form can be interpreted as undermining macro data as a verification basis for scientific inquiry.