What Are Rational Expectations?

Rational expectation is the expectation that the economic variables are the most accurate in the long-term on the premise of the effective use of all information, and are consistent with the economic theory and model used. It is named in the economic analysis assuming that the subject of economic behavior's "expectation" for future events is rational. And translate reasonable expectations. The idea of rational expectations was originally proposed by American economist J.F. Moose in the article "Theory of Reasonable Expectations and Price Changes". And N. Wallace and others made further development and gradually formed the school of rational expectations.

Rational expectations

(Economic term)

The formation of expectations becomes the object of economic analysis itself

Expectations are rational

That is to say, consumers take the maximum utility of consumption as the criterion of action, and producers maximize profit as the criterion of action. Any future situation expected by any economic actor when making the current decision will always be completely accurate What actually happens in the future.

Supply and demand equilibrium

As long as the market mechanism is fully functioning, the prices of various products and factors of production will change through supply and demand, and eventually their respective supply and demand will be in equilibrium. At this time, it is also in a state of equilibrium and full employment. The actual unemployment is limited to frictional unemployment, structural unemployment and voluntary unemployment. The employment rate, which is determined by the amount of employment in which the supply and demand of labor are consistent, is called the natural employment rate. The natural employment rate depends on a country's technological level, customs and resources, etc., and has nothing to do with monetary factors.

Rational expectation is essentially a concept of equilibrium, not just the rational assumptions of individual behavior. Only when it is integrated with the market equilibrium can we properly understand the rational expectation and the rational expectation equilibrium (REE). The demand for information in REE is not much more: traders only need to know the random process that generates equilibrium prices. Although the market clearing theory tells economists to determine the fundamental structural factors of price (such as the form of cost and demand functions), in equilibrium, traders do not need to know any form of economic structure, they only need to know the price and decision The relationship between the random factors of the output. Therefore, the essence of rational expectation is that market participants have some economic beliefs about the economic system, and they can associate the endogenous and exogenous variables of interest. Rational expectations have two characteristics.

According to the theory of rational expectation, the government should abandon the discretionary fiscal and financial policies, and the fiscal and financial policies should be aimed at preventing and reducing inflation rather than unemployment, with the most ideal price level as its sole policy objective.