Rational expectation theorists offer insight into why a monkey throwing darts at the wall street journal may be just as good of a financial advisor as anyone working at Fidelity (known as the efficient market hypothesis), but they also hold their theory to apply to government intervention. Basically, they hold the belief that due to expectation analysis neither fiscal nor monetary policy may play a large role in the economy. How can they be so right-on about stock market analysis but not about government intervention?
Here’s a quick response, please feel free to critique it.
Rational expectations is rooted in adaptive expectations where as people learn from their mistakes and learn to predict what interventions the government may do next. However, individuals are continuously entering and leaving the labor force (retirement, teenage work, etc). These individuals have no adaptive expectations because they have neither work experience nor voter experience. Thus, at bear minimum there will always be a margin of error for those entering in the workforce.
If you have some objection to RE Theory, please point it out. As far as I know it seems almost entirely correct.
They hold the belief that monetary policy will have an effect, but not the intended beneficial effect as market participants adjust to the policy, rendering the policy largely ineffective.
Your question is like asking: How come I cannot tell what will happen next time I throw the dice, but I CAN tell what will happen if I jump out of a window?
The first is subject to no forces but operates at random [for all intents and purposes]. In other words, what happened yesterday does not effect what happened today. The second is subject to the law of gravity. The place you jump from is VERY relevant to your future landing spot.
Similarly, what will happen in the stock market is hard to predict, because what happened yesterday is only one of many forces at work in the future. What happens a year from in the stock market depends on many unknowns [what deals are being done behind closed doors], and on all the events between the day of the prediction [say Jan 1] and the day being predicted about [say Dec 31]. You are taking a stab at knowing what will happen Dec 31 when you are missing a full calendar year of relevant info.
But prices today are very related to how much money was printed yesterday. And growth of the private sector is very related to how much was taken away yesterday in taxes.
Bottom line, when they say the unpredictable is unpredictable, they are right. When they say the predctable is unpredictable, they are wrong.
True they hold it will not have a positive effect but an extension of their hypotesis is that it will not have a negative effect either. They would hold there will not be large deviations from the market equilibrium. You cannot both hold rational expectations and ABCT