27+The+Role+of+Expectations+in+Macroeconomic+Policy

27+The+Role+of+Expectations+in+Macroeconomic+Policy - 1...

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Unformatted text preview: 1 27-1 The Role of Expectations in Macroeconomic Policy 27-2 The Role of Expectations in Macro Policy • Adaptive and Rational Expectations • Policy Conduct: Rules or Discretion? • The Role of Credibility and a Nominal Anchor • Establishing Central Bank Credibility 27-3 Adaptive and Rational Expectations • Adaptive expectations are formed from past experiences only . – Consequently, changes in expectations will occur slowly over time. 27-4 Adaptive and Rational Expectations • Rational expectations are formed from both past experiences AND predictions about the future . – Consequently, changes in expectations can occur very quickly when new information becomes available. 2 27-5 Adaptive and Rational Expectations • Rational expectations will be identical to optimal forecasts , i.e., the best guess of the future, using all available information. – However, a prediction based on rational expectations will not always be perfectly accurate . 27-6 Adaptive and Rational Expectations • Are households and businesses completely rational in their expectations? – Because accurate forecasts are desirable, there are strong incentives for households and businesses to use all available information in making optimal forecasts. 27-7 Adaptive and Rational Expectations • Are households and businesses completely rational in their expectations? – However, gathering and processing the information necessary to make optimal forecasts is both timely and costly which may lead households and businesses to form expectations that are less than completely rational....
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