Question

Are the implications of the rational and adaptive expectations hypotheses different in the short run?

o Yes, because under rational expectations theory, there is a significant time lag before people come to expect inflation and incorporate it into their decision making, whereas the adaptive expectations theory implies that people will begin to anticipate more inflation as soon as they observe a move toward a more expansionary policy.

o No, because under both theories, there is a significant time lag before people come to expect inflation and incorporate it into their decision making.

o Yes, because under adaptive expectations, there is a significant time lag before people come to expect inflation and incorporate it into their decision making, whereas the rational expectations imply that people will begin to anticipate more inflation as soon as they observe a move toward a more expansionary policy.

o No, because under both theories, people will begin to anticipate more inflation as soon as they observe a move toward a more expansionary policy.

Answer 1

The implications of rational and adaptive expectations are different in the short run; adaptive expectations imply a significant time lag in adjusting to new economic information, while rational expectations suggest people will quickly incorporate new information into their expectations and behavior.

Step-by-step explanation:

The implications of the rational expectations and adaptive expectations hypotheses are indeed different in the short run. Under the adaptive expectations theory, individuals use past experiences to gradually adjust their expectations. There is a significant time lag before they begin to expect inflation and incorporate it into their decision-making processes. This means adjustments in behavior and beliefs due to new information occur in incremental steps over time.

Conversely, the rational expectations theory posits that individuals form the most accurate possible expectations about the future by using all available information. This suggests that they would anticipate inflationary effects of a more expansionary policy more swiftly, without the time lag associated with adaptive expectations. Thus, economic adjustments in a rational expectations context may occur more rapidly compared to a situation where adaptive expectations prevail.

In summary, the answer to the student's question is: Yes, because under adaptive expectations, there is a significant time lag before people come to expect inflation and incorporate it into their decision making, whereas the rational expectations imply that people will begin to anticipate more inflation as soon as they observe a move toward a more expansionary policy.