8/14/2019 737-Expectations in Economics

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Expectations inEconomics

Guides to expectations

Consumer confidence surveys

Business confidence surveys

Long term interest rates - a

good guide to expectations of 

future inflation

Survey evidence tell ussomething about people's

short term expectations

Expectations implies that people

or economic agents" areengaged in "forward lookingbehaviour"

Expectations are f o recasts or v i ews that

decision makers hold about future prices,

sales, incomes, taxes, or other key variables

Expectations lie at the heart of 

speculative behaviour in marketsFinancial market investments

Exchange rates

Interest rates

House prices

Equity valuations

Commodity m arket speculation

Expectations influence the future t ime

path o f an economy because they shape

today's decisions - expectations can become

a "self-fulfilling prophecy"!

Imperfect foresight

hedging e.g. in commodity

markets - e.g. the hedging

done by the oil companies

Difference between short term

expectations and long-term expectations

Expectat ions af fect outcomes and

outcomes af fect expectat ions

Can government's changepeople's expectations?

 Adaptive expectations

Use past trends and errors in their earlier predictions

People form their expectations about what will

happen in the future based on what has

happened in the past

Linked to people's experiences in the economy

e.g. their experience of inflation - is actual

inflation = to forecast inflation

This involves using the recent

past to influence expectationsof the future

Rational expectations

Expectations as being identical to the

best guess of the future (the optimal

forecast) that uses all available

information

Over time, unexpected shocks

cancel themselves out

People's expectations about the

future will be accurate

People learn from their m istakes

"Lucas critique" of Keynesian

demand management

people learn to ant ic ipate

government po l icy changes

temporary changes in

government macroeconomic

policy become ineffective

Worth researching the work of 

Robert Lucas - one of thefounders of rational

expectations theory

Behavioural economics

Expectations are constrained

by limited information

Psychological biases may lead

to irrational behaviour

Persistent over-confidence via

profits forecasts or movements

in asset prices

Greenspan's "irrational exubera

quote a few years back 

Keynesian theory - possibility of 

irrational expectations

This is an increasingly

important strand of economic theory

Government economic

policy and expectations

Taxation and demand

Economists know the effect of a tax cut

will differ depending upon whether

consumers believe a personal income tax

cut is temporary or permanent

Expectations of inflation

 A credible monetary policy helps to

keep down expectations of inflation

This is where inflation targets can

be very useful - in shaping

expectations of inflation in the next

two to three years

Labour government believes

that stable expectations

promote higher investment and

sustainable economic growth

 Virtuous circles when

expectations are positive?

How quickly do ourexpectations adjust to

economic policy changes?

Macroeconomic

applications of expectations

Consumption theory

Life-cycle modelImportance of "expected future income"

Permanent income model

Interest rate expectations

Decisions about spending and saving

expectations of future income

expectations of future spending needs

expectations about future valueof pensions and asset prices

expectations about life expectancy

Housing market

price expectations

speculative demand

expectations of buy to let investors

Investment theory

Keynesian Marginal Efficiency

of Capital (MEC) theory

Expected real rates of return on capital

- Keynes referred to the "animal spirits"

of entrepreneurs - i.e. "waves of 

optimism and pessimism"

Expectations of the future level and

rate of growth of demand

 Attitudes to risk 

Expected returns from foreign

direct investment projects

Exchange ratesexpectations of future prices

interest rate expectations

Business confidence

Short term output projections - this will

influence decisions on employment and

investment

Willingness of businesses to accumulate

stocks of unsold products

Expectations about the future

prospects for the economy

Economic cycle

Changes in interest rates

Expectations of growth in key

export markets

Monetary Policy and Inflation

Expectations

Phillips Curve - drawn on the basis of a

given expected rate of inflationExpectations augmented PC

The role of inflation targets

Economic problems that can emerge

when people expect price deflation

Expectations at times of hyper-inflation

What indicators does the Bank 

of England use when shaping

their own expectations of 

inflation?Consumer and business surveys

Expectations of changes in the

exchange rate

Beliefs are important to thedecisions people make

Microeconomic

applications of expectations

Businesses -

expectations of 

price and

movements

Supply decisions - e.g. supply

decisions of producers in

agricultural markets

Planting and breeding decisions

based on price and income

expectations

Research the theory of "hog cycles"!

Strategic behaviour of rivals (game theory) -

e.g. expectations of how a rival might respond

to one price movement by another firm

Expectations may change in

"repeated games"

Wage bargaining in the labour market

inflation expectations

What effect does having an

inflation target have?

The Bank of England is involved

in "managing" people's

expectations about inflation

trade unions - and their power

to influence real wages

the "wage price spiral" where

wage demands follow prices

Choices of firms

and households

Expectations about the utility from

consuming different products

Expectations about how consumers may

respond to price and income changes

Expected incomes from different degree courses in

higher education - link to the tuition fees debate

Cost benefit

analysis

Expected private and social

benefits from major

infrastructural or other projects

Expected private and social

costs from large scale projects

Betting markets

Spread-betting

Easy to see people's

expectations in this market

Rational behaviour in betting markets

Betting exchanges Allows anyone to be a bookmaker

People can make up their own

odds and try to find a buyer

Expectations influence price,

output and investmentdecisions and how firms

compete against each other

xpectations.mmap - 08/11/2005 -