Академический Документы
Профессиональный Документы
Культура Документы
CONTENT:
1.0 INTRODUCTION
1.1 Definition
1.2 John Muth
4.0 CONCLUSION
5.0 REFERENCES
1. INTRODUCTION
The rational expectations theory is a revolutionary approach to macro-economics developed in the late
1970’s when it was viewed by many as radical, unlike today having attained a central position in macro-economic
theory and policy making.
In the 1970’s, the rational expectation school challenged the traditional Keynesian view of the world.
Economic models built on the ideas of Lord John Maynard Keynes treated the economy more or less as a system of
controllable inanimate objects blindly following rules. Models built on the ideas of rational expectations attempt to
acknowledge the ability of humans to change their behavior when they expect economic policies to change. The
repercussions of this dramatic shift in thought are still being felt among practicing macro-economic theorists and
policy makers.
1.1 DEFINITION
Rational expectations is an assumption in a model that the agent under study uses a forecasting mechanism
that is as good as is possible given the stochastic (random) processes and information available to the agent. Often
in essence, the rational expectations assumption is that the agent knows the model and fails to make absolutely
correct forecasts only because of the inherent randomness in the economic environment.
Muth (1960) puts forward his hypothesis “I should like to suggest that expectations, since they are informed
predictions of future events, are essentially the same as predictions of relevant economic theory. At the risk of
confusing this purely descriptive hypothesis with a pronouncement as to what firms ought to do, we call such
expectations rational”
4. CONCLUSION
In spite of its shortcomings, the rational revolution expectations theory is still accepted and has attained a
central position in micro-economic theory and policy making. Some economists now use the adaptive expectations
model but then complement it with ideas based on the rational expectations theory.
For example, an anti-inflation campaign by the Central bank is more effective if it is “credible”, i.e. if it
convinces people that it will stick to its guns. The bank can convince people to lower their inflationary expectations,
which imply loss of feed back into actual inflation rate.
An advocate of rational expectations would say rather that the pronouncements of central banks are facts
that must be incorporated into one’s forecast because central banks can act independently. Those studying financial
markets similarly apply the efficient-markets hypothesis but keep the existence of exceptions in mind.