Rational Expectations
AdvancedRational expectations is an economic theory that people form their expectations about the future, such as future inflation, using all available information and an understanding of how the economy works, so that their predictions are not systematically wrong.
The idea was introduced by economist John Muth in 1961 and developed by Robert Lucas and others in the 1970s. It contrasts with adaptive expectations, where people simply base their forecasts on past experience.
Under rational expectations, people may make mistakes, but those mistakes are random rather than consistently in one direction. If a government repeatedly tried to boost the economy with surprise inflation, people would learn to anticipate it, and the policy would lose its effect.
For example, if a central bank credibly announces it will keep inflation at 2%, workers and businesses with rational expectations will set wages and prices accordingly, making it easier to achieve the target.
The theory had a major influence on economics and policy, emphasising the importance of central bank credibility and predictable rules. Critics argue that real people have limited information and often behave less rationally than the theory assumes, as research in behavioral economics shows.
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