In many economic theories expectations about the future values of economic variables play an important causal role(s), since economic outcomes are influenced by the perceptions of various economic agents as to future economic state. Unfortunately the ...
In many economic theories expectations about the future values of economic variables play an important causal role(s), since economic outcomes are influenced by the perceptions of various economic agents as to future economic state. Unfortunately the mechanism by which economic agents form their expectations, in general, is not known. This unobservable feature of the expectation mechanism has led many attempts to find a good proxy or model for the expectation mechanism.
The traditional approach to this matter has been the use of current values rather than expected values of economic variables, based on the very unrealistic and simple hypothesis of convention that the current state of affairs continue indefinitely.
Dissatisfaction with this naive view has led two opposing approaches. The purely extrapolative expectation hypothesis seeks the rationality of the expectation mechanism in the learning process of the public through experience with past inflation rates, concluding that the monetary authority or government can conduct effective countercyclical policies, since inflationary expectation is solely a function of the past inflation series and so changes in economic policy variables play no effective role in the inflationary expectation by the public. The rational expectation hypothesis, on the other hand, looks for rationality from various other pertinent aspects apart from the learning process involving past inflation experience and insist that changes in economic policies have a very effective role in influencing the inflationary expectations. This, in effect, precludes the possibility that the monetary authority or government could control the course of inflation.
The purely extrapolative expectation hypothesis can be perceived to be a naive approach in view of the increasing array of other information which is made available, the accessibility of modem computer devices, and the role of the professional economic analysts. Achieving the optimal rationality of the expectation by the public, however, is still hampered by the constraints of the real time and information and computational costs of the expectation behaviour and also by what H. Simon refers to as the relativeness of the memorial power of human mind.
In this paper it has been attempted to reformulate the propositions of the rational expectation hypothesis in order that it can embody these aspects of the expectation mechanism of the economic agents and to conduct a hypothesis test. The result offers an empirical support for the hypothesis that the information contained in the intermediate indicators is intensively used in addition to the past inflation series through the sequential exploitation behavior of the public and so the changes in economic policy variables most-likely have indirect effects on the intermediate inflationary indicators. And it also provides an ecletic view that the countercyclical policies formulated according to a formulated rule or system do have some control over the course of inflation though their effects are not as potent as suggested by the purely extrapolative expectation hypothesists.