Adaptive expectations is an economic principle that predicts future performance based on past results, adjusting for errors. It fell out of favor in the 1970s due to limitations, and was replaced by rational expectations, which takes into account current trends. Irving Fischer created adaptive expectations, but also contributed to other economic theories.
Adaptive expectations is the economic principle of predicting future performance based on past results. This includes interest and inflation and your margin of error. The principle takes into account the errors revealed in previous forecasts and makes adjustments according to the actual results. For this reason, the principle is also known as the error-learning hypothesis. Adaptive expectations are used to predict values that are normally replaced by actual values as they unfold.
A typical equation used to calculate adaptive expectations will use a weighted average of the previous numbers. The difference between what was predicted in the past and what actually happened will also be included. Using this information to adjust forecasts for the future is known as partial adjustment. An equation can continually be adjusted to accommodate new real numbers and thus improve the chances of making an accurate prediction.
The principle of adaptive expectations gained popularity in the 1950s. After a few decades of widespread use, it fell out of favor in the early 1970s. This was primarily due to the inherent limitations of making projections based only on past performance and not including current trends . While the past has been an effective indicator in many respects, it has not been responsible for 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 fell out of fashion. Economist John Muth was one of the key figures involved in the creation of this theory in the early 1960s. It is based on the belief that if all available information, including past and current trends, is used properly, the only factor that can make dramatically inaccurate numbers is an unpredictable 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 just the expected behavior of people based on past events, but what appears to be happening in the present. Rational expectations assume that people generally won’t make mistakes in their predictions, whereas 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 was widely used. Fischer contributed to the field of economics in a number of other ways, including his influential theory of debt deflation, the Phillips curve, and the many books he wrote on investment and capital theory.
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