Editing Rational expectations (section)

== History ==
The concept of rational expectations was first introduced by [[John Muth|John F. Muth]] in his paper "Rational Expectations and the Theory of Price Movements" published in 1961. [[Robert Lucas Jr.|Robert Lucas]] and [[Thomas J. Sargent|Thomas Sargent]] further developed the theory in the 1970s and 1980s which became seminal works on the topic and were widely used in [[microeconomics]].<ref name=":0">{{Cite web |title=Rational Expectations |url=https://corporatefinanceinstitute.com/resources/economics/rational-expectations/ |access-date=2023-04-25 |website=Corporate Finance Institute |language=en-US}}</ref>

'''Significant Findings'''

[[John Muth|Muth’s]] work introduces the concept of rational expectations and discusses its implications for economic theory. He argues that individuals are rational and use all available information to make unbiased, informed predictions about the future. This means that individuals do not make systematic errors in their predictions and that their predictions are not biased by past errors. Muth’s paper also discusses the implication of rational expectations for economic theory. One key implication is that government policies, such as changes in monetary or fiscal policy, may not be as effective if individuals’ expectations are not considered. For example, if individuals expect inflation to increase, they may anticipate that the central bank will raise interest rates to combat inflation, which could lead to higher borrowing costs and slower economic growth. Similarly, if individuals expect a recession, they may reduce their spending and investment, which could lead to a [[Self-fulfilling prophecy|self-fulfilling prophecy]].<ref>{{Cite web |last=Muth |first=John.F |date=1961 |title=Rational expectations and the theory of price movements |url=https://citeseerx.ist.psu.edu/document?repid=rep1&type=pdf&doi=948a6261d8fc75496416ddf463fdb46cd171da32}}</ref>

[[Robert Lucas Jr.|Lucas]]’ paper “Expectations and the Neutrality of Money” expands on Muth's work and sheds light on the relationship between rational expectations and monetary policy. The paper argues that when individuals hold rational expectations, changes in the money supply do not have real effects on the economy and the neutrality of money holds. Lucas presents a theoretical model that incorporates rational expectations into an analysis of the effects of changes in the money supply. The model suggests that individuals adjust their expectations in response to changes in the money supply, which eliminates the effect on real variables such as output and employment. He argues that a stable monetary policy that is consistent with individuals' rational expectations will be more effective in promoting economic stability than attempts to manipulate the money supply.<ref>{{Cite web |last=Lucas |first=R.E |date=1970 |title=Expectations and the Neutrality of Money |url=http://www.economia.unam.mx/biblioteca/Pdf/T-III-BG-%20Expectations%20and%20the%20Neutrality.pdf}}</ref>

In 1973, [[Thomas J. Sargent|Thomas J Sargent]] published the article “Rational Expectations, the Real Rate of Interest, and the Natural Rate of Unemployment”, which was an important contribution to the development and application of the concept of rational expectations in economic theory and policy. By assuming individuals are forward-looking and rational, Sargent argues that rational expectations can help explain fluctuations in key economic variables such as the real interest rate and the natural rate of employment. He also suggests that the concept of the natural rate of unemployment can be used to help policymakers set macroeconomic policy. This concept suggests that there is a trade-off between unemployment and inflation in the short run, but in the long run, the economy will return to the natural rate of unemployment, which is determined by structural factors such as the skills of the labour force and the efficiency of the labour market. Sargent argues that policymakers should take this concept into account when setting macroeconomic policy, as policies that try to push unemployment below the natural rate will only lead to higher inflation in the long run.<ref>{{Cite web |last=Sargent |first=T.J |date=1973 |title=Rational Expectations, the Real Rate of Interest, and the Natural Rate of Unemployment |url=https://www.brookings.edu/wp-content/uploads/1973/06/1973b_bpea_sargent_fand_goldfeld.pdf}}</ref>