Adaptive Expectations

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  • A forecasting theory that is used to estimate the future direction of economic vari ables based on past occurrences or indicators and the margin of error associated with past predictions.

    Adaptive expectations is an integral component of the Phillips curve, the curve that shows an inverse relation ship between unemployment and inflation. Inflation is defined as a function of past inflation, cyclical unemploy ment, and supply shock (exogenous occurrences that have an impact on production—e.g., change in oil prices). If economic agents base their expectation of inflation on past inflation, inflation easily becomes inertial unless it is checked by something else. Consequently, if there is no supply shock and if unemployment is at the natural rate, that is, the nonaccelerating-inflation rate of unemploy ment (NAIRU), inflation ...

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