Adaptive vs. Rational Expectations in Macroeconomics

These flashcards cover the key concepts of adaptive and rational expectations in macroeconomics, highlighting their definitions, mechanisms, examples, limitations, and implications for economic policy.

What does the adaptive expectations hypothesis suggest?

Individuals form expectations about the future based on past experiences and trends.

How do expectations adjust in the adaptive expectations model?

Expectations adjust gradually over time as people learn from past mistakes.

What happens if inflation has been higher than expected in the past under adaptive expectations?

People would revise their future inflation expectations upwards.

What is a limitation of adaptive expectations?

It assumes a backward-looking process that can lead to systematic errors if the economic environment changes suddenly.

Who developed the rational expectations theory?

Robert Lucas.

What do individuals use to forecast future outcomes in rational expectations theory?

All available information, including current policies and economic theories.

In monetary policy, what do people do when a central bank announces an inflation target according to rational expectations?

They anticipate actions consistent with achieving this target and adjust their behavior accordingly.

What are the implications of rational expectations for economic policy?

Policy changes that are fully anticipated by the public will have no real effect on the economy.

What is a key difference between adaptive and rational expectations?

Adaptive expectations rely on past data while rational expectations use a broader set of information, including current policies.

Why might predictable policy interventions be neutralized in rational expectations?

Because individuals have already adjusted their behavior in response to the anticipated effects of these policies.