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The Rational Expectations Hypothesis: An Assessment from Popper's Philosophy


  • Ivan H. Ayala
  • Alfonso Palacio-Vera


The rational expectations hypothesis (REH) is the standard approach to expectations formation in macroeconomics. We discuss its compatibility with two strands of Karl Popper's philosophy: his theory of knowledge and learning, and his "rationality principle" (RP). First, we show that the REH is utterly incompatible with the former. Second, we argue that the REH can nevertheless be interpreted as a heuristic device that facilitates economic modeling and, consequently, it may be justified along the same lines as Popper's RP. We then argue that, our position as to the resolution of this paradox notwithstanding, Popper's philosophy provides a metatheoretical framework with which we can evaluate the REH. Within this framework, the REH can be viewed as a heuristic device or strategy that fulfils the same function as, for instance, the optimizing assumption. However, we believe that the REH imparts a serious methodological bias, since, by implying that macroeconomic instability is caused exclusively by "exogenous" shocks that randomly hit the economy, it precludes the analysis of any sources of inherent instability caused by the making of (nonrandom) errors by individuals, and hence it favors the creation of an institutional configuration that may be ill suited to address this type of instability.

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  • Ivan H. Ayala & Alfonso Palacio-Vera, 2014. "The Rational Expectations Hypothesis: An Assessment from Popper's Philosophy," Economics Working Paper Archive wp_786, Levy Economics Institute.
  • Handle: RePEc:lev:wrkpap:wp_786

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    References listed on IDEAS

    1. M. Woodford., 2010. "Convergence in Macroeconomics: Elements of the New Synthesis," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 10.
    2. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    3. Paul Davidson, 1991. "Is Probability Theory Relevant for Uncertainty? A Post Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 129-143, Winter.
    4. Arrow, Kenneth J, 1978. "The Future and the Present in Economic Life," Economic Inquiry, Western Economic Association International, vol. 16(2), pages 157-169, April.
    5. Hands, Douglas W., 1985. "Karl Popper and Economic Methodology: A New Look," Economics and Philosophy, Cambridge University Press, vol. 1(01), pages 83-99, April.
    6. Richard R. Nelson & Sidney G. Winter, 2002. "Evolutionary Theorizing in Economics," Journal of Economic Perspectives, American Economic Association, vol. 16(2), pages 23-46, Spring.
    7. Joseph E. Stiglitz, 2011. "Rethinking Macroeconomics: What Failed, And How To Repair It," Journal of the European Economic Association, European Economic Association, vol. 9(4), pages 591-645, August.
    8. Caldwell, Bruce J, 1991. "Clarifying Popper," Journal of Economic Literature, American Economic Association, vol. 29(1), pages 1-33, March.
    9. Friedman, Benjamin Morton, 2011. "Reconstructing Economics in Light of the 2007-? Financial Crisis," Scholarly Articles 5241348, Harvard University Department of Economics.
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    More about this item


    Popper; Knowledge; Rational Expectations; Learning; Trial; Error Elimination;

    JEL classification:

    • A12 - General Economics and Teaching - - General Economics - - - Relation of Economics to Other Disciplines
    • B41 - Schools of Economic Thought and Methodology - - Economic Methodology - - - Economic Methodology
    • B50 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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