A theme that dominates modern discussions of macro policy is the importance of expectations, and economists have devoted much thought to expectations and the economy. A change in expectations can shift the aggregate demand (AD) curve; inflation expectations can cause inflation. This is why expectations are at the heart of all political discussions, and what people think about policy significantly influences its effectiveness. Expectations greatly complicate models and policy making; they change the focus of discussions from a response that can be captured by simple models to much more complex discussions. Adaptive expectations theory assumes that people form their expectations of future inflation based on past and present inflation rates and only change their expectations gradually over time. the experience unfolds. In this theory, there is a short-term trade-off between inflation and unemployment that does not exist in the long term. Any attempt to reduce the unemployment rate beyond the natural rate triggers forces that destabilize the Phillips curve and shift it to the right. The rational expectations model was developed by Robert Lucas; rational economic agents are supposed to get the best possible benefit from everyone. information accessible to the public. Before reaching a conclusion, people are expected to consider all available information and then make informed, rational judgments about what the future holds. This does not mean that each individual's expectations or predictions about the future will be accurate. The errors that occur will be randomly distributed, so the expectations of a large number of people will be correct on average. To illustrate inflation expectations...... middle of paper ......, monetary and fiscal policy will work in different ways. People aren't stupid and they aren't super smart; they are people. If the government uses activist monetary and fiscal policy in predictable ways, people will eventually internalize this expectation into their behavior. If the government bases its prediction of the effect of its policy on past experience, that prediction will likely be wrong. But the government never knows when expectations will change. Let's take an example. Suppose everyone expects the government to implement expansionary fiscal policy if the economy is in recession. In the absence of any expected policy response from the government, people will lower their prices when they see a recession coming. They expect an expansionary policy from the government, but they will not lower their prices. So policy expectations can create their own problems.