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Econ: What are Rational Expectations? 5 Views


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What are Rational Expectations? Rational Expectations is a theory that people’s past economic experiences influence their perception of the future state of an economy, more so than policy changes by the government. On a microeconomic level, this can lead to self fulfilled predictions. On a macroeconomic level, rational expectations can lead to market turbulence when Central Bank policies don’t count factor them in their decisions on interest rates or monetary policy.

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Transcript

00:00

And finance Allah shmoop what are rational expectations Alright people

00:07

Well life can change pretty quickly One day you're the

00:10

CEO of a Wall Street hedge fund making a fifteen

00:13

twenty thirty million dollars a year or more than one

00:16

bad experience with a cursive monkey paw and poof You're

00:19

the break dance guy on the subway busking for ninety

00:22

bucks a day in tips Yeah I guess you shouldn't

00:24

have wished to become a better dancer Well but given

00:26

that you can never tell exactly what will happen in

00:28

the future how do you decide what to do Day

00:31

today Lt'll economists have a model they use It's called

00:34

rational expectations The theory assumes that people make economic decisions

00:38

based on their reasonable assumptions about what's gonna happen in

00:42

the future Folks look at their current situation and it

00:44

what's happened in the past and from there they make

00:47

educated guesses about what's likely to happen in the future

00:50

Well these expectations in turn become the bases or foundation

00:53

for their decision making Gas prices have been low forest

00:56

long as you can remember so you don't care much

00:59

about fuel efficiency when you go out and buy a

01:01

car So you go for the ten miles a gallon

01:04

Hummer Rational expectation Until militants take over Saudi Arabia's largest

01:09

oil production field gas prices spike Now you're paying two

01:12

hundred dollars a month to fill your gas tank Remember

01:15

a lot of economic activity is based on what people

01:17

think will happen in the future Will people borrow money

01:20

planning to pay it back years In the future they

01:23

buy houses with thirty year mortgages They choose college majors

01:26

with an eye toward a forty year career Well aside

01:29

from philosophy majors maybe people make decisions based on what

01:33

they think the future will be like right Robert Lucas

01:36

won the Nobel Prize in nineteen ninety five for his

01:38

work on the theory of rational expectations This guy well

01:42

quick fun fact When Lucas Scott divorce from his wife

01:45

Rita in the late nineteen eighties the divorce agreement included

01:48

a stipulation that she would get half of his Nobel

01:51

Prize winnings if he ever won the award However the

01:53

Klaus had an expiration date of Halloween nineteen ninety five

01:57

He officially won his prize on October tenth nineteen ninety

02:00

five just under the wire So okay most of us

02:03

don't rationally expect our spouse is to win half a

02:06

Nobel Prize kind of money but most of us are

02:08

just happy if they remember to put down the toilet

02:10

seat But yeah we do make other long term decisions

02:13

based on what we think we'll be able to make

02:15

on an ongoing basis in your hedge fund days You

02:17

wouldn't think twice about taking on a five million dollar

02:20

mortgage for a vacation place in Bermuda However you never

02:24

take on that responsibility If you knew that your monkey

02:26

paw wish was going to go sideways and you know

02:29

leave you with eighteen thousand dollars in annual salary your

02:32

rational expectations impact your big long term money making decisions

02:37

They also play into your smaller data day decisions Even

02:40

deciding what you're going to have for dinner relates to

02:42

how much money you expect to make in the near

02:44

future Will the precursor version of you while you then

02:47

might have gotten the nine course tasting menu It hearsay

02:50

with the caviar Black Australian truffles flog raw and wagyu

02:54

beef The bill would run six hundred bucks a person

02:57

but you can afford it So like who cares The

03:00

post curse break dance version of you might decide to

03:02

go with the Junior Bacon cheeseburger off Lindy's Value menu

03:06

which costs a buck ninety nine Yeah that's all you

03:08

can afford But the rational part of rational expectations assumes

03:12

that your predictions will stem from past experience Unless you've

03:15

had trouble with cursing objects before it's unlikely that you'll

03:18

see the bad wish scenario coming Given that you've been

03:21

a fifteen million dollars plus a year hedge fund manager

03:24

for twenty years at five million dollars vacation home or

03:27

good seems very manageable There's no reason to expect your

03:30

job to change The reasonable assumption is that you'll keep

03:33

your fat salary for the foreseeable future Well dinner's at

03:36

per se a vacation spots in Bermuda Yeah but then

03:39

you wandered into that dingy curiosity shop on your last

03:43

trip to Hong Kong and asked the man behind the

03:44

counter if he had anything really interesting Then he started

03:48

stroking his beard and well on the bright side you

03:51

always wanted to be able to do the worm Yeah 00:03:55.178 --> [endTime] Yeah

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