The rational expectations hypothesis implies that use of discretionary macro-policy as a stabilization tool will
A) be ineffective, even in the short run.
B) be effective in the short run but ineffective in the long run.
C) be effective both in the short run and long run.
D) make it possible to trade-off a higher rate of inflation for a lower rate of unemployment.

Question

Quizplus · Accepted Answer

The rational expectations hypothesis suggests that individuals form expectations about future economic conditions based on all available information, including past experiences and current policies. Therefore, any discretionary macro-policy action taken by the government will be anticipated by individuals and incorporated into their expectations. As a result, any short-term benefits of the policy will be offset by changes in individual behavior that negate the intended effects, making the policy ineffective in the short run. Over the long run, individuals will adapt their behavior to the policy, rendering it ineffective in the long run as well.

The Rational Expectations Hypothesis Implies That Use of Discretionary Macro-Policy