The rational expectations revolution

The rational expectations revolution

The rational expectations revolution swept through the economics profession in the 1970s in a way that no other set of ideas had done since Keynes. Although largely associated with the free-market, non-interventionist wing of economics, the rational expectations revolution has been far more wide reaching. Even economists implacably opposed to the free market have nevertheless incorporated rational expectations into their models.

  The rational expectations revolution is founded on a very simple idea. People base their expectations of the future on the information they have available. They don’t just look at the past, they also look at current information, including what the government is saying and doing and what various commentators have to say.

  The new classical economists use rational expectations in the following context. If the long run Phillips curve is vertical, so that a expansionary policy will in the end merely lead to inflation, it will be difficult for the government to fool people that this will not happen. If employers, unions, city financiers, economic advisers, journalist, etc. all expect this to happen, then it will do: and it will happen in the short run. Why should firms produce more in response to a rise in demand if their costs are going to rise by just as much? Why should higher wages attract workers to move jobs, if wages everywhere are going up? Why should firms and unions not seek price and wage rises fully in line with the expected inflation?

  But can the government not surprise people? The point here is that ´surprising´ people really only means ´fooling´ them – making them believe that an expansionary policy will reduce unemployment. But why should the public be fooled? Why should people believe smooth-talking government ministers rather than the whole host of critics of the government, from the opposition, to the economic commentators, to the next-door neighbour?

  The rational expectation school revised the old saying, “You can’t fool all the people all the time” to “You can hardly fool the people at all”. And if that is so, argue the new classical economist, unemployment can only be momentarily brought below its natural level.

  Two of the most famous rational expectations economists are Robert Lucas and Thomas Sargent. Robert Lucas, like Milton Friedman and many other famous conservative economist, has his academic base in the University of Chicago, where he has been professor since 1974. in 1995, like Milton Friedman in 1976, Lucas was awarded the Nobel prize in economics. Tom Sargent was professor at the University of Minnesota but is now a senior fellow at the Hoover Institution of Stanford University.

Citerat ur John Sloman, Economics, London 2000

skapad av Håkan Danielsson, lärare i historia/samhällskunskap på Katedralskolan i Lund