Question

Which of the following accurately explain the impact of an unexpected shift to a more expansionary monetary policy under rational and adaptive expectations? Check all that apply.

a. Under the adaptive expectations hypothesis, people will integrate the shift to the more expansionary monetary policy into their forecast of the future inflation rate.
b. Under the rational expectations hypothesis, people will not change their expectations until there is an actual increase in the rate of inflation.
c. Under the adaptive expectations hypothesis, people will not change their expectations until there is an actual increase in the rate of inflation.
d. Under the rational expectations hypothesis, people will integrate the shift to the more expansionary monetary policy into their forecast of the future inflation rate.

Answer 1

Under rational expectations, people integrate an expansionary monetary policy shift into their future inflation forecasts immediately (option d). Under adaptive expectations, individuals adjust expectations only after observing actual changes in inflation (option c). Options a and b are inaccurate for their respective expectations hypotheses.

Step-by-step explanation:

To understand the implications of an unexpected shift to a more expansionary monetary policy, it is important to differentiate between rational expectations and adaptive expectations. With the rational expectations hypothesis, individuals use all available information to formulate forecasts about future economic conditions, including changes in monetary policy. As such, they will immediately integrate the shift to the more expansionary policy into their forecasts of future inflation, even before actual inflation occurs. This matches option d, indicating rational expectations lead to pre-emptive adjustments in behavior.

In contrast, the adaptive expectations hypothesis suggests that individuals rely on past experience to guide their expectations for the future. They will only gradually adjust their beliefs and behavior as they observe actual changes, such as an increase in the inflation rate. Therefore, under adaptive expectations, people wouldn't revise their expectations until they see the policy's effect on the economy, suiting option c.

Option b, suggesting that people under rational expectations will not change their forecasts until there is an actual increase in inflation, contradicts the definition of rational expectations. Consequently, option a aligns with adaptive expectations, as it describes how people would incorporate the more expansionary policy into their future inflation forecasts.

Answer 2

D and B

Step-by-step explanation:

Rational expectation will include the present as well as the past trend to build the future expectations. So, presence of unexpected expansionary policy, will make them build expectations of the future. But, adaptive expectations relies on the past information. It means that inflation actually happened, when make people to adapt the future expectation.