Economic Theories: Inflation Estimation and Actual Inflation Correlation

Inflation Estimation and Actual Inflation Correlation

Prev Question Next Question

Question

An economic researcher publishes evidence that the consensus inflation estimation for the following year has no correlation with the actual inflation level the year before. The estimation error is often very large, but does not display a pattern. Which of the following theories would this evidence support?

Answers

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E. F.

E

Under the rational expectations hypothesis, individuals will form inflation expectations based on all relevant information available. Therefore a comparison of expected and realized inflation would show a random estimation error and no correlation with past estimates. The adaptive expectations hypothesis suggests that individuals will base their views of the future on their recent experience.

Under this theory, estimations would show a pattern in the error. Expected inflation would tend to be too high following a period of high inflation, and then too low follow a period of limited inflation.

Prev Question Next Question