RATIONAL EXPECTATIONS:
Most macroeconomista today routinely sclve their models under the assumption of rational
expectations. This was not always the case The last 40 years in macroeconomic researah ans often called
the ‘rational expectations’ revolution The importance of expectations is an old theme in
macroetonamics. But un the early 1970 macroeconomim thought of expectations in one of two ways:
*One was as animal spirits (from an expression Keynes introduced in the Generof Throry to refer
movementa in investmant that could not be explained by movementa in current vartables. In scher
words, shitts in wxpectations were considered important but were left unexplained.
• The other was the rent of simpie, backoward-looking rules For exumple, people were often assumed
to have statie expectations. that , to expect the tuture to be like the present (we uned this assumption
when diacutsing the Philips curve in Chapter 8, and when exploring investment decisions in Chapter 16).
Or pengle were assumed to have adaptive expectations If for example, their forecast of a gven variable
ina given period turned aut to be too low, people wure asumed to ‘adape’ by raising their pectation for
the value of the variable for the failowing period. For uxample, seeirg an inflation rate higher than they
had expected led people to revtse upward their forecast of infution in the future.
In the early 1970s,a group of matrosconamista lud by Robert Lutas (at Chicago) wd Thoeas Sargent
argued that thee asumptions did not reflect the way people form expectations. (Robert Lucas recolved
the Nebel Prize in 1995, Thamas Sargent received the Nobel Prize in 2011 They argued that, in thinking
