expectations


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expectations

the view taken of likely future events and changes by persons and firms which serves to influence their current economic behaviour. For example, a holder of a FINANCIAL SECURITY may anticipate that its price is likely to fall in the near future, and this may encourage him to sell the security now rather than incur (an expected) reduction in profits or even losses in the future (see SPECULATION, HEDGING); a TRADE UNION may anticipate that INFLATION is likely to rise, which causes it to put in a demand for a wage increase for its members which in part reflects (an expected) higher rate of future inflation.

expectations

anticipations of future events that influence present economic behaviour. A major unresolved problem in economics is how to deal with the uncertainty that the future holds, especially when each individual has a different subjective perception of that future. In addition, ‘bandwagon’ effects can mean that, once an economy starts to expand, people become more optimistic and so spend and invest more, with cumulative effects. See RISK AND UNCERTAINTY.

Consequently, much economic analysis incorporates expectations into the various models as a given variable, usually under the heading CETERIS PARIBUS, or by assuming that an individual acts in accordance with the RATIONAL EXPECTATION HYPOTHESIS. A further problem is that expectations involve a time period and much economic analysis is static, i.e. points of equilibrium may be observed but the route between them is considered irrelevant. (See COMPARATIVE STATIC ANALYSIS.)

Nevertheless, expectations have played a significant part in economic theory, most notably in the work of KEYNES. Expectations are a major variable, it is argued, in determining BUSINESS CYCLES and affecting the SPECULATIVE DEMAND for money. Expectations are also influential when dealing with the TERM STRUCTURE OF INTEREST RATE.

To incorporate expectations into economic theory, it is possible to treat individual behaviour as adaptive, as illustrated in the ADAPTIVE EXPECTATION HYPOTHESIS.

Although the concept is straightforward, future expectations being adapted from past and present experiences, the attempts to reflect reality have led to complex structures being formulated.

The simplest form of expectations models are extrapolative expectations models where people form expectations about a future economic event like inflation based upon their assumption that the past trend in inflation will continue into the future. See KEYNESIAN ECONOMICS, EXPECTATIONS-ADJUSTED/AUGMENTED PHILLIPS CURVE, SPECULATOR, ANTICIPATED INFLATION, TRANSMISSION MECHANISM.

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