Expectations and economic theory: the boundaries of rationality

Economic theory has incorporated expectations in its mainstream. Expectations were modeled by Keynes and his successors in several ways. Economists following Keynes held the view that government spending was required to achieve full employment and economic growth. However, new classical economists argued that people would foresee the inflationary impact of government actions, which would undo their effects. Rational expectations could stifle initiative under conditions of perfect foresight. However, uncertainty and decentralized decision-making can create steady growth by fulfilling investor expectations. This reduces the role of the state and underlines the significance of institutions and markets.