Rational expectations

Rational expectations is the hypothesis that forecasts use available information and knowledge of how an economic system works. Errors may occur, but they are not systematically predictable from information already available.

Expectations operator: A mathematical operator representing a forecast conditional on specified information. Rational-expectations models define forecasts as conditional expectations given available information.
John F. Muth: An American economist who introduced the rational-expectations hypothesis in a 1961 article. Muth first formulated the idea as a model of expectations consistent with economic structure.
Adaptive expectations: A forecasting rule that updates expectations using past forecast errors or observed outcomes. Unlike rational expectations, it need not use the full available information set.
Rational expectations equilibrium: An equilibrium in which agents’ expectations are consistent with the probability distributions generated by the model. It formalizes the hypothesis as a consistency condition within an economic equilibrium.
Rational inattention: A theory in which people choose how much information to acquire because processing it has a cost. It explains why forecasts may omit information even when agents behave optimally.
Lucas critique: The argument that policy evaluations based on historical correlations can fail when policy changes alter behavior. It shows why forecasts must account for how policy changes expectations and decisions.
Rational Expectations and the Theory of Price Movements: John F. Muth’s 1961 article introducing rational expectations in models of commodity prices. This article established the hypothesis before it became central to macroeconomic theory.
Bounded rationality: A decision-making approach in which cognitive limits and scarce information constrain optimization. It relaxes the strong information-processing assumptions often used in rational-expectations models.
Inflation expectations: Beliefs about the future rate of increase in the general price level. How these beliefs form affects wage setting, prices, and the effects of monetary policy.
Heterogeneous expectations: The coexistence of different beliefs or forecasts among people facing the same economic conditions. It challenges representative-agent treatments that assign everyone the same expectations.

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