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Essay / Research Paper Abstract
A paper which looks at the tradeoff between unemployment and inflation in the light of the rational expectations theory, with specific reference to the Bank of England's fiscal policies. Bibliography lists 2 sources.
Page Count:
3 pages (~225 words per page)
File: JL5_JLratexp.rtf
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be central banks, public corporations, private companies or individuals. For instance, a company might use such a model in order to set wage levels based on the degree of inflation
which is predicted for the following year, or the value of shares assessed according to its predicted future income. The rational expectations theory states that expectations are the same as
the optimal forecast which incorporates all the available information. Rational expectations theory was developed in response to the earlier theory of adaptive expectations, which broadly
states that people will base their predictions of future events on what has happened previously. If there has been a high rate of inflation in the past, then it is
anticipated that it will be high in the future. In other words the future value of an economic variable is deduced according to its value in the past. Such a
model is flawed since it relies solely on past performance without taking into account other relevant information. It is also constricting, in that it assumes the rational individual will, quite
irrationally, not take into account current as well as past events in predicting future ones. Logically, this means that predictions cannot take into account fiscal
policies: one would be estimating future inflation rates on past performance, even in the light of Bank of England policies which clearly indicate the possibility of a different rate.
Rational expectations theory assumes that predictions are made on the basis of all available information, and therefore even though the expectations may not be correct, the deviations will not be
out of line with expected values. Miller (2005) states that people base their expectations on the "true state of the world" and therefore, it is
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