The Remarkable Persistence of the Rational Expectations Hypothesis

The rational expectations hypothesis was first made explicit and applied by John Muth (1961) in a microeconomic setting, but the hypothesis is closely associated with Robert Lucas and the new classical school of thought in macroeconomics that evolved from the early 1970s. However, new classical models also include the assumption of continuous market clearing. While such market-clearing models are nowadays the exception rather than the rule, the rational expectations hypothesis has endured as part of the current synthesis in macroeconomics (Woodford 2009). Given the various criticisms of rational expectations, this paper examines the remarkable persistence of the hypothesis from two different perspectives. First, Uskali Maki’s distinction between “realism” and “realisticness” is employed to reconstruct the arguments of Muth and Lucas in justifying rational expectations, using the different attributes of realisticness as terms of reference. Second, a distinction is made between individual and market rationality. Some criticisms of rational expectations lose their force when the hypothesis is interpreted in the context of market rather than individual rationality.