Adaptive expectations by pc10201


									Adaptive expectations
From Wikipedia, the free encyclopedia

In economics, adaptive expectations means that people form their expectations
about what will happen in the future based on what has happened in the past.
For example, if inflation has been higher than expected in the past, people would
revise expectations for the future.
One simple version of adaptive expectations is stated in the following equation,
where    is the next year's rate of inflation that is currently expected;   is this
year's rate of inflation that was expected last year; and   is this year's actual rate
of inflation:                                                                                        Economies by region
                                                                                         Africa · North America · South America · Asia ·
                                                                                                        Europe · Oceania ·

where is between 0 and 1. This says that current expectations of future inflation                     General categories
reflect past expectations and an "error-adjustment" term, in which current                    Microeconomics · Macroeconomics ·
                                                                                          History of economic thought · Methodology ·
expectations are raised (or lowered) according to the gap between actual inflation
                                                                                                     Heterodox approaches ·
and previous expectations. This error-adjustment is also called "partial
                                                                                                      Technical methods
                                                                                         Mathematical · Econometrics · Experimental ·
The theory of adaptive expectations can be applied to all previous periods so that                  National accounting ·
current inflationary expectations equal:                                                             Fields and subfields
                                                                                         Behavioral · Cultural · Evolutionary · Growth ·
                                                                                             Development · History · International ·
                                                                                                       Economic systems ·
                                                                                              Monetary and Financial economics ·
where       equals actual inflation years in the past. Thus, current expected               Public and Welfare economics · Health ·
inflation reflects a weighted average of all past inflation, where the weights get        Education · Welfare · Population · Labour ·
                                                                                           Personnel · Managerial · Computational ·
smaller and smaller as we move further in the past.
                                                                                            Business · Information · Game theory ·
Once a forecasting error is made by agents, due to a stochastic shock, they will          Industrial organization · Law · Agricultural ·
be unable to correctly forecast the price level again even if the price level            Natural resource · Environmental · Ecological ·
experiences no further shocks since they only ever incorporate part of their errors.        Urban · Rural · Regional · Geography ·

The backward nature of expectation formulation and the resultant systematic                                  Lists
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errors made by agents (see Cobweb model) was unsatisfactory to economists
                                                                                                          Economists ·
such as John Muth, who was pivotal in the development of an alternative model
                                                                                             The economy: concept and history
of how expectations are formed, called rational expectations. This has largely
replaced adaptive expectations in macroeconomic theory since its assumption of                    Business and economics portal

optimality of expectations is consistent with economic theory.                                                                  V   · T· E·

   George W. Evans and Seppo Honkapohja (2001), Learning and Expectations in Macroeconomics. Princeton University
   Press, ISBN 978-0-691-04921-2.

See also
   Rational Expectations
   Policy Ineffectiveness Proposition
   Self-fulfilling prophecy
   Problem of induction

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