Expectations are model consistent, on average, in a RE framework, so errors are made, but on average they are zero.


In a rational expectation framework, do all agents know the true law of motion of the economy? But they make errors, only on average, they are correct, right? So, the average agent does know the law of motion then? But this agent does not exist... . Well actually the average agents equals the individual agent, because all agents are the same, representative agents? But how then do you explain the random errors with zero mean?

  • 2
    $\begingroup$ Hi: There are two (or even three ? ) different forms of rational expectations assumptions. Some are more restrictive than others. Pesaran's 1987 book ( best book I've ever seen on rational expectations ) may explain the difference. I'll google and see what I can find. $\endgroup$
    – mark leeds
    May 21 '20 at 12:41
  • $\begingroup$ Ok, thanks! Most versions assume full information and perfect foresight I guess, although the latter is necessarily implied by rational expectations $\endgroup$ May 21 '20 at 12:42
  • $\begingroup$ There may be better explanations but this has sections on weak form RE and strong form RE. www2.econ.iastate.edu/tesfatsi/reintro.pdf $\endgroup$
    – mark leeds
    May 21 '20 at 12:43
  • $\begingroup$ Thanks, sadly my institution has no access to Pesaran's book. $\endgroup$ May 21 '20 at 12:46
  • $\begingroup$ Hi: Perfect foresight means that the agent can predict the future exactly but this is not what RE says. I would definitely go through atleast the first few chapters of Pesaran's book. It really opened my eyes as far as understanding RE. I struggled to find a good book so when I eventually found that one, it was like finding gold. I think it's called "The Limits of Rational Expectations". $\endgroup$
    – mark leeds
    May 21 '20 at 12:46

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Browse other questions tagged or ask your own question.