Are Rational Expectations for Real?

Are Rational Expectations for Real?
Auth.: R.Craine, G.Hardouvelis
Journal: Greek Economic Review, April 1983, 5: 5-32.


The concept of rational expectations is intuitively appealing because it appears to be an application of the fundamental principle of individual opti-mizing behavior that underlies all economic theory.

When the payoff from a decision depends on unknown future events, the decision maker, implicitly or explicitly, assigns subjective probabilities to the events that may affect the payoff. The outcomes of decisions are observable, but the subjective beliefs of individuals are unobservable.

As a result, without a restriction on individual subjective beliefs any decision can reflect optimal behavior, and the theory of optimal decision making under uncertainty is empty. Even psychotic behavior can be optimal given a sufficiently distorted perception of the world.

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