Rational Expectations Theory

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Rational Expectations Theory

In economics, a theory stating that economic actors make decisions based on their expectations for the future, which are based on their observations and past experiences. A basic example of rational expectations theory is a situation in which a consumer delays buying a certain good because, based on his/her observations and experiences, he/she believes that the price will be less expensive in a month. If enough consumers believe that, demand eases and the good is likely to actually be less expensive next month. Thus, the consumer waits a month before buying the good. Rational expectations theory states that current expectations strongly influence future performance. Economists disagree about how well the rational expectations theory works in the real world.
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Sargent using application of the rational expectations hypothesis came to the conclusion that a coordinated monetary policy has no effect on the elimination of unemployment and production increase.
The rational expectations hypothesis (REH) is a theoretically attractive framework for assessing the mechanism with which economic agents process information when formulating judgments about the real world (Krause 2000).
The test was initially conceived to test the rational expectations hypothesis in macroeconomics, to supply a statistical comparison between a measure of pricing by the market (valuation coefficient) and another of rational expectations (forecasting coefficient) given by a relevant variable.
11) So, this answer to the rational expectations critique only applies if rational expectations are rare--a claim that the rational expectations hypothesis denies.
Tests of the rational expectations hypothesis (REH) outside the experimental laboratory typically utilize two types of data: quantitative measures of expectations about publicly observed variables such as inflation, usually elicited from small samples of professional forecasters; and qualitative measures of expectations about privately observed variables such as personal income, elicited from large samples of households.
Another important theme of the book is that traditional methods of economic inquiry, such as the efficient market hypothesis and the rational expectations hypothesis, are not well suited for analyzing financial bubbles.
John Muth (1961) was the first to formulate the rational expectations hypothesis in a precise way.
Finally, the study considers whether anyone group within the three aforementioned fields acts most consistently with the rational expectations hypothesis.
Prior studies using traditional regression or standard co-integration methodology to test rational expectations hypothesis (REH) for time-series data characterized by unit root processes could be suspect and lead to incorrect inferences.
According to the Rational Expectations Hypothesis as developed by Lucas (1972), Muth (1961) and Sargent and Wallace (1976), for examples, all anticipated or expected price changes have no real effects on the economy.
Now clearly the switch from the fixed-lag to the rational expectations hypothesis was the consequence primarily of theoretical, rather than empirical, analysis.
I agree with Brunner that the full-information version of the rational expectations hypothesis provides valuable insights for certain problems but is incapable of explaining some important phenomena.