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Rational expectations is an economic theory that seeks to infer the macroeconomic consequences of individuals' decisions based on all available knowledge. It assumes that individuals' actions are based on the best available economic theory and information.
Robert Hall was the first to derive the effects of rational expectations for consumption. His theory states that if Milton Friedman’s permanent income hypothesis is correct, which in short says current income should be viewed as the sum of permanent income and transitory income and that consumption depends primarily on permanent income, and if consumers have rational expectations, then any ...
Lucas (1972) incorporated the idea of rational expectations into a dynamic macroeconomic models. The agents in Lucas's model are rational: based on the available information, they form expectations about future prices and quantities, and based on these expectations they act to maximize their expected lifetime utility. [ 18 ]
The concept of rational expectations was originally used by John Muth, [10] and was popularized by Lucas. [11] One of the most famous new classical models is the real business cycle model, developed by Edward C. Prescott and Finn E. Kydland.
Lucas (1973) [r] proposed a business cycle theory based on rational expectations, imperfect information, and market clearing. While building this model, Lucas attempted to incorporate the empirical fact that there had been a trade-off between inflation and output without ceding that money was non-neutral in the short-run. [ 124 ]
The policy-ineffectiveness proposition (PIP) is a new classical theory proposed in 1975 by Thomas J. Sargent and Neil Wallace based upon the theory of rational expectations, which posits that monetary policy cannot systematically manage the levels of output and employment in the economy.
Rational expectations were developed by John F. Muth and later translated into macroeconomic theory by Robert Lucas Jr., Thomas Sargent, Leonard Rapping, and others. [ 2 ] Depending on author and context, the term "Carnegie School" can refer to either both branches or only the bounded rationality branch, sometimes with the qualifier "Carnegie ...
It suggests consumption patterns are formed from future expectations and consumption smoothing. [α] The theory was developed by Milton Friedman and published in his A Theory of the Consumption Function, published in 1957 and subsequently formalized by Robert Hall in a rational expectations model.