Adaptive expectations use past performance to predict future performance, with adjustments made based on actual results. It fell out of favor in the 1970s due to limitations, and was replaced by rational expectations which take into account current trends. Irving Fischer created adaptive expectations but also contributed to the economic field in other ways.
Adaptive expectations are the economic principle of predicting future performance based on past performance. This includes interest and inflation and their margin of error. The standard takes into account errors found in previous forecasts and makes adjustments based on actual results. For this reason, the principle is also known as the learning error hypothesis. Adaptive expectations are used to predict data that is typically replaced with actual values as it unfolds.
A typical equation used to calculate adaptive expectations will use a weighted average of past figures. The gap between what was predicted in the past and what actually happened will also be understood. Using this information to adjust predictions for the future is known as biased adjustment. An equation can be continuously adjusted to accommodate new actual figures and thus improve the chances of making an accurate prediction.
The principle of adaptive expectations became popular in the 1950s. After a couple decades of widespread use, it fell out of favor in the early 1970s. This is mainly due to the limitations inherent in making projections based only on past performance and not including current trends. While the past was an effective indicator in many respects, it could not explain the development of trends and unforeseen events in the present day that were changing the economic climate.
A new principle known as rational expectations became popular when adaptive expectations went out of fashion. Economist John Muth was one of the main figures involved in creating this theory in the early 1960s. He is based on the belief that if all available information, including past and current trends, is used correctly, the only factor that could make the figures dramatically inaccurate is an unforeseen event or trend.
Rational expectations are somewhat similar to adaptive expectations in that they are primarily based on what people expect. The main difference is that it takes into account not only people’s expected behavior based on past events, but what appears to be unfolding in the present. Rational expectations assume that people generally do not make mistakes in their predictions, while adaptive expectations are centered on how errors affect a prediction.
Yale economist Irving Fischer created the principle of adaptive expectations. He died in 1947, before his theory of him became widely used. Fischer has contributed to the economic field in many other ways, including his influential theory of debt deflation, the Phillips curve, and the many books he has written on the theory of investment and capital.
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