Background
Expectations in economics refer to the conjectures or forecasts that economic agents make about future values of economic variables such as prices, interest rates, and market conditions. These forecasts significantly influence individuals’ and organizations’ choices, which in turn shape the trajectory of the economy.
Historical Context
The concept of expectations has roots in early economic thought, but it gained significant attention in the mid-20th century with the development of Keynesian and later New Classical and Rational Expectations theories. These schools of thought emphasized the central role of expectations in determining macroeconomic and microeconomic outcomes.
Definitions and Concepts
- Expectations: The forecast or view of economic agents about the future values of economic variables.
- Adaptive Expectations: The hypothesis that people form their expectations about the future based on past experiences and gradually adjust them as reality unfolds.
- Exogenous Expectations: Assumptions in economic models where expectations are determined outside the model itself.
- Extrapolative Expectations: Assumptions where future expectations are derived from the extension of current trends.
- Rational Expectations: Theist that posits individuals will make forecasts about the future based on all available information, effectively assuming that on average, they will predict unbiased outcome.
- Self-fulfilling Expectations: Situations where beliefs or expectations can induce a behavior that causes the expected event to actually happen.
Major Analytical Frameworks
Classical Economics
Classical economists traditionally assumed that markets were in equilibrium and that expectations remained static or were not central to economic modeling.
Neoclassical Economics
As an evolution from classical thought, neoclassical economics generally assumed agents had perfect information. However, some neoclassical models began incorporating expectations about future prices and markets.
Keynesian Economics
John Maynard Keynes introduced the idea that expectations, particularly in investment, were clouded by uncertainty and had a profound impact on economic cycles.
Marxian Economics
Marxian economics often considers the expectations of labor and capital owners within the power dynamics of capitalism, although specific models of expectations are less emphasized.
Institutional Economics
Institutional economics places significant importance on the rules and norms which may shape expectations, particularly through historical paths and institutional frameworks.
Behavioral Economics
Behavioral economics examines how bounded rationality, cognitive biases, and emotions can influence expectations, leading them to deviate from purely rational forecasts.
Post-Keynesian Economics
Post-Keynesian theorists focus heavily on the role of uncertainty and expectations in a fundamentally unpredictable dynamic economic system.
Austrian Economics
Austrian economists emphasize the role of individual expectations in market processes, heightened by their focus on entrepreneurial discovery and the time structure of production.
Development Economics
In development economics, expectations play essential roles in investment decisions, savings behavior, and the general progress of emerging economies.
Monetarism
Monetarists, especially those following Milton Friedman, argue that adaptive expectations explain how people anticipate inflation based on past monetary policy.
Comparative Analysis
Major economic theories diverge significantly in how they interpret and integrate expectations. While rational expectations assume nearly perfect prognostic capacity, adaptive expectations highlight potential lags. Behavioral economics introduces biases, making the analysis more nuanced and less deterministic compared to their more classical and neoclassical counterparts.
Case Studies
- Hyperinflation in Zimbabwe: Adaptive expectations of inflation showed how people’s past experiences anticipated future realities, exacerbating hyperinflation conditions.
- Dot-com Bubble: Rational and extrapolative expectations involving tech stocks, which included overly optimistic future projections, illustrated self-fulfilling prophecies.
- Asian Financial Crisis: The crisis showcased dual roles of expectations – both adaptive and rational – with investor sentiment rapidly changing and sparking economic turmoil.
Suggested Books for Further Studies
- “Expectations in Economics” by David F. Hendry.
- “Rational Expectations and Inflation” by Thomas J. Sargent.
- “The Essence of Uncertainty: How Rational Expectations Keywords the Future” by Richard Adlington.
Related Terms with Definitions
- Adaptive Expectations: The mechanism adjusting forecasts based on past data.
- Exogenous Expectations: Predictions set independently of a theoretical model.
- Extrapolative Expectations: Future expectations formed by projecting current trends.
- Rational Expectations: Forecasting future values accurately using all available information.
- Self-fulfilling Expectations: Predictions influencing actions directly, consequently verifying the predicted outcome.
