Rational Expectations Theory[]

"In recurrent situations the way the future unfolds from the past tends to be stable, and people adjust their forecasts to conform to this stable pattern." - Thomas Sargent

If we think of a stock price. It is common to assume that the price reflects all of the available information about the stock. If there was other information, someone would make money on the poop stock. This is a similar idea to the expectation that the Rational Expectations economist has when looking at economic agents. While acknowledging that the market for stocks has few of the distortions that other markets have, this paradigm allows for pretty good predictions of behavior, largely as a result of the observation that with large numbers the deviations start to cancel out.

The fundamental idea of incorporating people's expectations is not new, just the specific way of orienting the theory in a way which seems to lend power of analyis.

In Business Cycle models the errors in rational expectations may explain why cycles occur. In a Fisher Black sense, excessive noise would be sufficent for a cycle.

See Also[]