JAYOTI VIDYAPEETH WOMEN'S UNIVERSITY, JAIPUR
Government of Rajasthan established
Through ACT No. 17 of 2008 as per UGC ACT 1956
NAAC Accredited University
Faculty of Education and Methodology
Faculty Name- JV’n Dr. Md Meraj Alam
Program- BA (Hons) Economics 2nd Semester
Course – Macroeconomics II
Digital session name – Adaptive Expectation
Introduction:
Yet another approach to expectations formation, which can also be viewed as a special case
of the extrapolative hypothesis has come to dominate much of the work done on
expectations. This is the adaptive expectations hypothesis, first put forward by Cagan (1956)
and Neriove (1958). It states that expectations are revised in accordance with the last
forecasting error; hence its alternative name, the error learning hypothesis.
Another variation of the extrapolative theme, which has received some prominence recently,
is the regressive (effect-cause relationship)—extrapolative expectations hypothesis. This was
first put forward by Duesenberry (1958) and expanded by Modigliani and Sutch (1966).
They suggest that there might be both extrapolative and regressive elements present in the
process by which expectations are formed. The latter implies a reversion of expectations
towards a long run ‘normal’ level, which may in itself be given parameter of the system, or a
lagged function of actual price changes, where the lag may extend over several years. In the
latter case, the hypothesis once more becomes a special case of the general extrapolative
hypothesis.
This mechanism of adaptive expectations formation is more frequently used in economics.
According to this mechanism of adaptive expectations agents revise their expectations in
each period according to the degree of error in their previous expectations—hence the name
adaptive expectations. The speed at which the expectations adjust to past error is called the
coefficient of adaptations. This coefficient may fluctuate between zero and one. Thus, with
adaptive expectations, the expected value in the next period is equal to the expectations for
the current period plus or minus a proportion of the error in the expectations for the current
period.
Until the idea of rational expectations was introduced in economics, adaptive expectations
were the most common method of formulating expectations in economics. Its popularity was
due to its conceptual simplicity and the ease with which, it could be implemented
empirically. Statistical estimates for the coefficient of adaptive expectations can be easily
obtained.
Moreover, according to Carter and Maddock the adaptive behaviour in the face of an
uncertain environment appears intuitively very plausible and appealing. Adaptive
expectations model worked well in a climate in which the change was gradual—a
characteristics of the 1950s and the 1960s when the inflation rates were low and relatively
stable and when inflation rates underwent fast changes and increased rapidly, adaptive
forecasts were left behind.
Thus, adaptive expectations are effective when the variable being forecast is reasonably
stable, but adaptive expectations’ are of little use in forecasting trends. Moreover, there may
be additional or supplementary information available to the forecaster which is a highly
relevant to the variable being forecast for example knowledge of which party has won a
general election may be used to forecast the rate of inflation which is otherwise based only
on past price data.
Mechanical application of an adaptive expectations mechanism, therefore, does not
essentially make the best use of all the scarce information available. It is for this reason that
this mechanism as a for caster of economic behaviour is not very dependable. Under some
peculiar circumstances, it has been observed that the adaptive expectations mechanism
performs poorly. Rather than converging to zero, the expectations errors increased from year
to year.
Course Outcome: The goal of this paper will be to expose the students to the basic
principles of macroeconomics. The emphasis will be on thinking like an economist and
course will illustrate how economic concepts can be applied to analyse real-life situations. In
this course, the students are introduced to money and interest, theories of inflation, rate of
interest, trade cycle and growth models.
