The rational expectations hypothesis assumes that individuals will
A) never make forecasting errors.
B) be as likely to overestimate as to underestimate the future rate of inflation.
C) continually make systematic forecasting errors.
D) ignore past forecasting errors when formulating predictions.

Question

Quizplus · Accepted Answer

The rational expectations hypothesis assumes that individuals have unbiased and accurate expectations about future economic variables, but recognizes that errors can still occur. Therefore, individuals are equally likely to overestimate as to underestimate the future rate of inflation, leading to unbiased forecasts on average. Choice A is incorrect because the rational expectations hypothesis acknowledges the possibility of forecasting errors. Choice C is incorrect because the hypothesis assumes individuals make unbiased forecasts. Choice D is incorrect because past forecasting errors are taken into account when individuals form expectations for the future.

The Rational Expectations Hypothesis Assumes That Individuals Will