Already have an account? Get multiple benefits of using own account!
Login in your account..!
Remember me
Don't have an account? Create your account in less than a minutes,
Forgot password? how can I recover my password now!
Enter right registered email to receive password!
Limitations of the theory of rational expectations:
Critics of this theory note that if policy makers have more information about the economy or their own actions than does the general public, policies can be devised that will alter output and employment. To illustrate, suppose clandestinely, the monetary authority increases the growth rate of the money supply. Since the more rapid increase in the money supply is unanticipated, output and employment increases. Of course, if the rational expectations view is correct, output and employment will return to their original levels after the public learns of the new policy. Consequently, the policy is effective only during the learning process, which may be short-lived. In the case where policy makers possess more information about the economy, it might be easier for them to disseminate the information and let the public act on it rather than going for new policy options.
A second limitation of the theory of rational expectations has to do with the assumption of wage and price flexibility. Under the theory, money wages and prices are assumed flexible. But due to various reasons, they may be "sticky." As a consequence, even if expectations are formed rationally, money wages and prices may adjust slowly, resulting in changes in output and employment. Suppose, for example, that aggregate demand decreases. Assuming that households and firms anticipate the change, money wages and prices should fall so as to leave output and employment unchanged. But if money wages and prices are sticky, output and employment decrease, contrary to the theory of rational expectations. Critics of the theory claim that money wages and prices adjust only slowly over time. Thus, they believe that discretionary policy can alter output and employment, at least in the short run. Proponents of the theory respond by arguing that the role of policy would be limited in this context, since repeated use of policy will lead to changes in the types of contracts that are negotiated. The effects of these changes will reduce or eliminate the ability of policy makers to alter the equilibrium levels of output and employment through the use of a systematic policy.
Opponents of this theory charge that the rational expectations theory cannot explain the prolonged periods of unemployment that we sometimes experience, especially in advanced industrialized economies. If expectations are formed rationally and if wages and prices are flexible, they claim that deviations from the equilibrium levels of output and employment should be short-lived. Since this implication appears to be inconsistent with actual experience, many critics reject the theory on this basis. In response, proponents have constructed theories of the business cycle based on rational expectations. These theories are capable of explaining the observed movements in output and employment.
As we have discussed above, the theory of rational expectations is controversial. In fact, there is currently no universally accepted theory about expectations. At present only a small minority of economists appear to support the theory of rational expectations. On the other hand, support seems to be growing. Because of the theory's implications for the conduct of policy, resolution of the controversy is very important. The theory of rational expectations together with efficient market clearing led to the emergence of supply-side economics.
what are the purposes of taxation?
What are three modifications to a polymer that can make it transparent? How will these modifications affect the mechanical properties of the polymer?
Define the tools of Competitive market. Competitive market: The supply and demand model a. The demand curve b. The supply curve c. Factors which cause the demand cu
Supply of labor, L S (W/P), depends positively on real wages in classical model. It isn't always clear which individuals are included in the labor supply. Labor supply may consist
OPEC oil cartel becomes subject to this tension or conflict such that the cartel gives way to a more competitive oil market resulting in a dramatic decrease in the world oil price.
How are individual makes choices? Fundamental principles behind the individual choices are as follows: 1. Resources are scarce . 2. The real cost of anything is what y
How do countries grow Economic growth? Economic growth is attaining by increasing: • Quantity of resources by investment • Quality of resources by training as well as R
Bruno's Lunch Counter is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets. These assets wil
what is money multiplier? what is role , importance, advantages , disadvantages , limitations and examples of money multiplier?
Question 1: Discuss why living standards are higher in some countries than others. Question 2: (a) How is inflation measured? (b) What are the causes and consequence
Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!
whatsapp: +91-977-207-8620
Phone: +91-977-207-8620
Email: [email protected]
All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd