Adaptive expectations
Topic: Schools of Economic Thought and Economic Laws · NCERT: Beyond NCERT
Meaning
Adaptive expectations is the idea that people predict the future value of something, such as inflation, from its past values. If their last guess was wrong, they correct it slowly. The idea is linked with Milton Friedman and Edmund Phelps. Because expectations trail behind reality, a government can "fool" people for a while. For example, it can push unemployment down by creating surprise inflation. The effect lasts only until expectations catch up.
Example
Suppose prices have risen about 6% a year for some time. Workers ask for wage rises of about 6%. If inflation then climbs higher, their expectations rise only slowly, a little each year, as they notice their past forecasts were too low.
Don't confuse with
- Rational expectations (Muth, 1961; Lucas; Sargent): people use all available information and the correct model of the economy, not just past values. So systematic policy cannot keep fooling them. This result is called policy ineffectiveness.
Related concepts
- Monetarism
- Chicago school
- Cantillon effect
- Rational expectations
- Lucas critique
- Real business cycle theory
- Tinbergen rule
- Austrian school
- Economic calculation problem
- Supply-side economics