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Macroeconomic Theory$
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Jean-Pascal Benassy

Print publication date: 2011

Print ISBN-13: 9780195387711

Published to Oxford Scholarship Online: April 2015

DOI: 10.1093/acprof:osobl/9780195387711.001.0001

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Rational Expectations

Rational Expectations

(p.45) 3 Rational Expectations
Macroeconomic Theory

Jean-Pascal Bénassy

Oxford University Press

This chapter first defines rational expectations, which is an extension to stochastic environments of the idea of perfect foresight. It characterizes the original Muth (1961) model, which exhibits how a number of results on the proliferation of shocks and stability are evaluated. Also, it discusses the efficacy of government policy and reveals that the prominent result attained under the notion of perfect foresight carries through in a stochastic environment. Further, it examines a very famous macroeconomic model, the Cagan (1956) model, which was initially designed to see whether price dynamics could degenerate into hyperinflation. The dynamics of the model are compared under two different expectations schemes: adaptive expectations and rational expectations. The chapter then investigates the set of solutions to a stochastic dynamic equation.

Keywords:   rational expectations, stochastic environments, perfect foresight, Muth model, Cagan model, stochastic dynamic equation

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