Rational Expectations
The theory that people form unbiased economic forecasts using all available information.
What is Rational Expectations?
Rational expectations is an economic theory, developed by John Muth in 1961 and applied to macroeconomics by Robert Lucas, holding that individuals and firms form expectations about the future by efficiently using all available relevant information. Under rational expectations, forecast errors are random and unpredictable — people are not systematically wrong. This has profound policy implications: if individuals anticipate government policy changes and adjust behavior accordingly, systematic monetary or fiscal policy interventions cannot predictably raise output or employment — they are 'priced in' by rational actors. The theory became central to New Classical Economics and the policy ineffectiveness proposition, challenging Keynesian activism.
Example
If the Federal Reserve announces it will increase money supply to stimulate employment, rational expectations theory predicts that workers and firms will immediately raise wage and price demands in anticipation of the resulting inflation. The real effects of the policy wash out quickly, leaving only higher inflation — supporting the view that only unexpected (surprise) monetary policy changes can have temporary real effects.
Source: Federal Reserve Bank of Minneapolis — Robert Lucas and Rational Expectations