Rational expectations

The theory of rational expectations is a macroeconomic theory, originally developed by John F. Muth ( 1961) and was later developed by Robert E. Lucas. He received the Nobel Prize in Economics for this theory in 1995.

The theory is used to model how economic expectations are formed. It finds its use especially in the new classical macroeconomics, the neo-Keynesianism and financial market theory.

Theory and policy statements

The essence of this theory is that no systematic or predictable rational expectations differ from the results that arise in free markets ( market equilibrium ). It is thus assumed that economic agents do not commit systematic errors with respect to their expectations. In economic models, this means that the expected value of a variable from the resulting value by the market mechanism only by a stochastic error term differs. The expected value of this error term is always zero. This implies that economic agents know the market mechanism and the reactions of supply and demand to changing prices anticipate.

Suppose is the current equilibrium price on a simple market. According to the theory of rational expectations, the expected price is then:

Where e denotes an equilibrium price from independent, random disturbance whose expected value is zero.

The theory of rational expectations has been developed as an alternative model to the theory of adaptive expectations. With adaptive expectations expected values ​​based on the observed values ​​in the past and approach the equilibrium values ​​only asymptotically. With rational expectations, however, are included all the information about the market in the expectation formation with. Although rational expectations can be wrong, but the error is always random and not systematic.

This theory provides the basis for many economic policy conclusions that are controversial among economists scientists. According to the Keynesian view, the central bank can reduce unemployment by expansionary monetary policy. But an expansion of the money supply leads under the assumption of rational expectations to the fact that higher inflation is expected. In anticipation of higher inflation and the nominal wages are accordingly adjusted upwards, so that real wages remain the same. The government would only increase the rate of inflation in this case, unemployment would remain constant. Representatives of the new classical macroeconomics are therefore of the view that expansionary monetary and fiscal policy can affect the real values ​​neither in the short nor the long run. Keynesian economic policy would be in their opinion useless.

Criticism

The theory of rational expectations is often criticized as an unrealistic model of expectation formation. In particular, will not consider that information is always associated with costs, so the critics. Since rational expectations assume perfect information, is too expensive an optimal rational prediction. Due to the uncertainty and unpredictability of the future wholly rational expectations are impossible.

Next, the assumption is criticized that there is any market only a balance, which can calculate rational economic agents. In the case of multiple equilibria denied the theory of rational expectations.

The message of the new classical macroeconomics that expansionary economic policy was ineffective, is replies that wages are not fully flexible at least in the short run and did not immediately respond to a higher expected inflation (for example, through long-term wage agreements ). Thus, an expansionary monetary policy would be at least in the short term effect.