Question

For this discussion, assume that rational expectations theory is correct and that monetary policy is most effective in changing the economy when it catches people and businesses by surprise. Given this, should short-term data on the economy and on monetary policy targets be published? Defend your answer using the rational expectations theory.

Answer 1

The theory of rational expectations tells us that poeple react according to their expectations about the economy and that will in more cases affect what the state of the economy actually turns out to be in the future. Given this, it might be more beneficial for the authorities to release the information before they actually take the policy action, as that will be more instrumental in bringing about the necessary change. Consider the state when the economy is in a inflationary phase. If the monetary authorities are planning to reduce the money in circulation to control the inflation rate, then this information should be available to the people before hand. This is because if the people get to know that the money in hand is going to reduce in the future, then they will keep more money in hand instead of spending it now, which will automatically reduce the level of prices in the economy, even before the central bank actually increases the interest rates to reduce the money in circulation. This is in accordance to the rational expectations theory as it is will be expected by the people that money in hand will reduce in the future, and hence they will reduce their spending today, which will achieve the desired effect of reduced inflation in the economy.