Adaptive expectations

Definition

Adaptive expectations or adaptive behavior or backward-looking expectations refers to a phenomenon where people's expectations or projections of the future are unduly influenced by recent trends, and are thus liable to deviate systemically from rational expectations and rational behavior. The contrast is thus between adaptive expectations, that are backward-looking, and rational expectations, that are forward-looking.

Note that adaptive behavior is not diametrically opposite to rational behavior, and in a slow-changing economy, adaptive behavior may be good enough for most purposes. However, if people are adaptive rather than rational, it is possible for governments to exploit this through policies that would not be possible if people were rational.

Examples

Adaptive expectations about prices

People with adaptive expectations might believe that if the price of a commodity has been rising in the recent past, it will continue to rise in the future, despite the fact that the price is merely converging towards an equilibrium.

Adaptive expectations about taxes

People with adaptive expectations about taxes might believe that a reduction in the current tax rate implies low tax rates in the future, thus increasing their marginal propensity to spend and reducing their need for saving. The rational behavior might well lead to the opposite conclusion: low tax rates today, combined with higher spending, means greater government debt that the government will try to alleviate by raising taxes in the future.