Institutions, Expectations and Aggregate Demand

Abstract

The concept of rational expectations is the cornerstone of orthodox economic theory. As Minford and Peel (2002) argue: ‘in its modern guise macroeconomics is based entirely on the idea that agents are rational. Hence rational expectations are central to the subject today’ (p. 41). Although the conclusions reached by the mainstream about, for instance, the reasons for and duration of economic disequilibria, the causes of economic cycles, and the impact of economic policy are based on this way of analysing the economic behaviour of individuals, in most undergraduate textbooks, this way of representing how individuals make their economic decisions is not made explicit. In fact, in most textbooks that discuss competing schools of economic thought and their main differences, it is not explained that these schools can be grouped into two main approaches, according to their treatment of the information problems: schools that identify information problems with situations of risk, and schools that treat information problems in terms of uncertainty.