<p>Expectations are model consistent, on average, in a RE framework, so errors are made, but on average they are zero.</p>

<p>thus</p>

<p>In a rational expectation framework, do all agents know the true law of motion of the economy? But they make errors, only on average, they are correct, right? So, the average agent does know the law of motion then? But this agent does not exist... . Well actually the average agents equals the individual agent, because all agents are the same, representative agents? But how then do you explain the random errors with zero mean?</p>

CC BY-SA 4.0
2020-05-21T12:41:06.640Z
Hi: There are two  (or even three ? ) different forms of rational expectations assumptions. Some are more restrictive than others. Pesaran's 1987 book ( best book I've ever seen on rational expectations )  may explain the difference. I'll google and see what I can find.
mark leeds
CC BY-SA 4.0
2020-05-21T12:42:39.063Z
Ok, thanks! Most versions assume full information and perfect foresight I guess, although the latter is necessarily implied by rational expectations
Beck Batucada
CC BY-SA 4.0
2020-05-21T12:43:47.193Z
There may be better explanations but this has sections on weak form RE and strong form RE. http://www2.econ.iastate.edu/tesfatsi/reintro.pdf
mark leeds
CC BY-SA 4.0
2020-05-21T12:46:17.393Z
Thanks, sadly my institution has no access to Pesaran's book.
Beck Batucada
CC BY-SA 4.0
2020-05-21T12:46:28.140Z
Hi: Perfect foresight means that the agent can predict the future exactly but this is not what RE says. I would definitely go through atleast the first few chapters of Pesaran's book. It really opened my eyes as far as understanding RE. I struggled to find a good book so when I eventually found that one, it was like finding gold. I think it's called "The Limits of Rational Expectations".
mark leeds
CC BY-SA 4.0
2020-05-21T12:47:51.797Z
Hi: You can get it used on Amazon for pretty cheap. Be careful what you read on RE because I have found that a lot of it can be more hurtful ( confusing ) than helpful.
mark leeds
CC BY-SA 4.0
2020-05-21T14:18:29.970Z
Well, it's not in the definition of rational expectations, but as RE are always model consistent on average in e.g. a DSGE model, this basically coincides/implies with perfect foresight, I think.
Beck Batucada
CC BY-SA 4.0
2020-05-21T14:18:47.033Z
yes this one: https://www.cambridge.org/core/journals/econometric-theory/article/limits-to-rational-expectations-by-m-hashem-pesaran-basil-blackwell-1987/76FB6E08BAC5915271324148B4330199

but got no time for shipping issues sadly
Beck Batucada
CC BY-SA 4.0
2020-05-21T14:50:34.813Z
Well, it depends on your definition of RE if it implies perfect foresight, but in the applied definition used in DSGE models, I think it does.

See Dave Smants comment:
"
Cook and Hahn (1990, p.14) state: "there is a distinction between the specialized form of the rational expectations hypothesis used in the literature ... and the general principle of rational expectations, which is that market participants use available information efficiently in forming their expectations."
Beck Batucada
CC BY-SA 4.0
2020-05-21T14:50:38.287Z
"
Thus, empirical tests of expectations and forecasts relying uncritically on the REH-perfect-foresight-with-error model are simply testing a caricature, or, at best, a very general first approximation of reality. Rational expectations is NOT perfect foresight. 
"
Beck Batucada
CC BY-SA 4.0
2020-05-21T23:02:27.430Z
Maybe there are even different definitions of perffect foresight ? Even if the book is going to be late for your needs, I highly recommend it. I was mostly confused by the RE books ( and explanations ) that I read until I found that book. Good luck and I hope the book can help with what you're doing.
mark leeds
<macroeconomics><dynamic-optimization><rational-expectations>
In a rational expectation framework, do all agents know the true law of motion of the economy?
Beck Batucada
# In a rational expectation framework, do all agents know the true law of motion of the economy?

(Asked by: username_0 on 2020-05-20)

Expectations are model consistent, on average, in a RE framework, so errors are made, but on average they are zero.

thus

In a rational expectation framework, do all agents know the true law of motion of the economy? But they make errors, only on average, they are correct, right? So, the average agent does know the law of motion then? But this agent does not exist... . Well actually the average agents equals the individual agent, because all agents are the same, representative agents? But how then do you explain the random errors with zero mean?

**Tags:** macroeconomics, dynamic-optimization, rational-expectations
> **Comments:**
> **username_1**: Hi: There are two  (or even three ? ) different forms of rational expectations assumptions. Some are more restrictive than others. Pesaran's 1987 book ( best book I've ever seen on rational expectations )  may explain the difference. I'll google and see what I can find.  
> **username_0**: Ok, thanks! Most versions assume full information and perfect foresight I guess, although the latter is necessarily implied by rational expectations  
> **username_1**: There may be better explanations but this has sections on weak form RE and strong form RE. http://www2.econ.iastate.edu/tesfatsi/reintro.pdf  
> **username_0**: Thanks, sadly my institution has no access to Pesaran's book.  
> **username_1**: Hi: Perfect foresight means that the agent can predict the future exactly but this is not what RE says. I would definitely go through atleast the first few chapters of Pesaran's book. It really opened my eyes as far as understanding RE. I struggled to find a good book so when I eventually found that one, it was like finding gold. I think it's called "The Limits of Rational Expectations".  
> **username_1**: Hi: You can get it used on Amazon for pretty cheap. Be careful what you read on RE because I have found that a lot of it can be more hurtful ( confusing ) than helpful.  
> **username_0**: Well, it's not in the definition of rational expectations, but as RE are always model consistent on average in e.g. a DSGE model, this basically coincides/implies with perfect foresight, I think.  
> **username_0**: yes this one: https://www.cambridge.org/core/journals/econometric-theory/article/limits-to-rational-expectations-by-m-hashem-pesaran-basil-blackwell-1987/76FB6E08BAC5915271324148B4330199  but got no time for shipping issues sadly  
> **username_0**: Well, it depends on your definition of RE if it implies perfect foresight, but in the applied definition used in DSGE models, I think it does.  See Dave Smants comment: " Cook and Hahn (1990, p.14) state: "there is a distinction between the specialized form of the rational expectations hypothesis used in the literature ... and the general principle of rational expectations, which is that market participants use available information efficiently in forming their expectations."  
> **username_0**: " Thus, empirical tests of expectations and forecasts relying uncritically on the REH-perfect-foresight-with-error model are simply testing a caricature, or, at best, a very general first approximation of reality. Rational expectations is NOT perfect foresight.  "  
> **username_1**: Maybe there are even different definitions of perffect foresight ? Even if the book is going to be late for your needs, I highly recommend it. I was mostly confused by the RE books ( and explanations ) that I read until I found that book. Good luck and I hope the book can help with what you're doing.  

---

## 0 answers

