Will the price level be rising or falling, and if so, by how much?
[SOUND] The reason inflationary expectations are important is that
they play a critical role in how labor and management interests
determine wage levels in the collective bargaining process.
And such inflationary expectations can also strongly influence the savings and
spending pattern of consumers.
In these ways, inflationary expectations can contribute to actual inflation.
[SOUND] Let me show you what I mean with an example from the collective bargaining
process using a behavioral model known as adaptive expectation.
[MUSIC]
In general, economists use two forms of expectations in their models and
theories, adaptive expectations and rational expectations.
[SOUND] With adaptive expectations,
people are assumed to use past information as the best predictor of future events.
Thus, if inflation was 3% last year, people are likely to
assume it'll be 3% next year, that's adaptive expectation.
In contrast with rational expectation,
people use all available information to predict future events.
