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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The rational expectations hypothesis was originally suggested by John (Jack) Muth (1961) to explain how the outcome of a given economic phenomena depends to a certain degree on what agents expect to happen.
The rational expectations hypothesis has dominated research programs in macroeconomics since the seventies.
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.
2003), the rational expectations hypothesis predicts says that asset prices are determined by their expected cash flows.
Finally, one needs to explore the model's public policy implications: Lucas's [Lucas, 1976] work on the implications of the rational expectations hypothesis earned him a Nobel Prize in 1995.
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.