rational-expectations hypothesis

rational-expectations hypothesis

a HYPOTHESIS that suggests that firms and individuals predict future events without bias and with full access to relevant information at the time the decision is to be made. Only ‘new’ information will have an effect on EXPECTATIONS or behaviour.

Business expenditure on investment and stocks is affected greatly by the expectations that businessmen have of the future. These expectations, for instance, are major contributory elements in determining the BUSINESS CYCLE. If businessmen operated under conditions of total knowledge, then the business cycle in its present form would cease to exist. Expectations play a major part in wage-bargaining whereby each side (employers and employees) have to anticipate future events such as the rate of inflation. MONEY ILLUSION would not exist and employment would be based on real wages at all times.

The rational-expectations model is perhaps more applicable to markets approaching PERFECT COMPETITION and is rather less successful when applied to modern macroeconomic problems. See also ECONOMIC MAN.

References in periodicals archive ?
To Aggregate, Pool or Neither: Testing the Rational-Expectations Hypothesis Using Survey Data.
The error-learning that the rational-expectations hypothesis entails should be rapid if: (a) the stochastic part of the process being forecast is stationary and asymptotically mean-convergent and (b) data on reported outcomes can be verified costlessly.
The rational-expectations hypothesis is a crisp implementation of the assumption that the public understands the implications of the policy rule.
Lucas joined the rational-expectations hypothesis to the assumption of continuous market clearing and monetary neutrality to underwrite the "surprise-only" analysis of aggregate supply On this view, money has no effect except when the public mistakes neutral changes in the price level for economically significant changes in relative prices; the rational-expectations hypothesis (Muth 1961) guarantees that such mistakes are short-lived.
One approach challenges fundamental features of Lucas's analysis--particularly, the rational-expectations hypothesis or rapid market clearing.
Cummins and Outreville (1987) also emphasize that historical information is used to develop a rational-expectations hypothesis with institutional lags, This hypothesis suggests that underwriting cycles reflect the presence of data collection lags, regulatory lags, and policy renewal lags in a rational-expectations framework.