Page 267 - DECO402_Macro Economics

Macroeconomic Theory Ashwani Panesar, Lovely Professional University

Notes Unit-30: Rational Expectations Hypothesis

Contents
Objectives
Introduction
30.1 Adaptive Expectations
30.2 Rational Expectations
30.3 Basic Propositions of Rational Expectations Hypothesis
30.4 Stabilisation Policy and Ratex Hypothesis
30.5 Summary
30.6 Keywords
30.7 Review Questions
30.8 Further Readings

Objectives

After studying this unit, students will be able to:
y Know the Adaptive Expectations,
y Know the Rational Expectations,
y Know the Stabilisation Policy and Ratex Hypothesis.

Introduction

In the decade of 1930, when Keynes wrote his “General Theory”, then the main problem of the world
was unemployment. During the Second World War, inflation emerged in form of the main economic
problem. After the world war, unemployment again emerged as a problem till the decade of 1960. Till
next one century, unemployment and inflation jointly took a new form, which was called stagflation.
This new problem of stagflation became a challenge before the policy makers and economists, because
this theory of Keynes was silent on this subject. Hence a new macroeconomic theory was born by this
crisis situation which was named “Rational Expectations Hypothesis OR Ratex”.

30.1 Adaptive Expectations

Before discussing about the Ratex hypothesis, it is important to understand the meaning of adaptive
expectations used in macroeconomics which was developed before the Ratex theory.
Expectations are forecast or predictions made by any financial agent in relation to those uncertain
economic factors which are related to his decisions. Forecasts, along with the tendencies of the past,
are based on current information and experience. Main part of economic theory, in development of
expectations by the financial agents (i.e., consumers, producers etc.) is based on assumption of their
rational behaviour. But till now economists, in measurement of human behaviour, have not been able
to include the role of expectations. Keynes discussed the importance of expectations but he was silent
on the fact that how are they developed?

260 LOVELY PROFESSIONAL UNIVERSITY