Rational Expectations

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  • What economic agents use, in the absence of perfect foresight, to anticipate economic policies and minimize their effects. By incorporating past and present information, economic agents can aggregate information to such an extent that, on aver age, they are not consistently wrong. If economic agents can aggregate information and form rational expectations, forecasting errors will be the result of exogenous (stochastic) shocks or changes and not systematic miscalculation.

    The theory has aroused controversy in economic literature. The theory's central thrust can be related to the ineffectiveness of stabilization policies when econo mic agents have rational expectations. For example, a 3% expansionary policy, which might cause a 3% increase in inflation, might prompt rational agents to demand higher wages of about 3% to offset the cost of ...

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