Rational expectations theory implies that the more completely the effects of policy makers are foreseen, the smaller their short run effects on real output and unemployment, and the greater their short run effects on the price level.

Question

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Rational expectations theory suggests that individuals base their expectations on all available information, including the expected effects of policy. If policy effects are completely foreseen, then individuals will adjust their behavior accordingly, resulting in smaller short run effects on real output and unemployment. However, if the policy effects are not fully anticipated, it may result in greater short run effects on the price level.

Rational Expectations Theory Implies That the More Completely the Effects