Evidence on the rationality of expectations in the British manufacturing sector

• Published in: Applied economics 1983-08, Vol.15 (4), p.425-436
• Main Authors: Tompkinson, Paul, Common, Michael
• Format: Article
• Language: English
• Subjects: Economic theory; Hypotheses; Manufacturing; Polls & surveys; Rational expectations; Statistical analysis; Studies; Supply & demand
• ISSN: 0003-6846; 1466-4283
• DOI: 10.1080/00036848300000014

In both theoretical and empirical macroeconomics, Muth's (1961) assumption of rational expectations is becoming increasingly popular. However, this rational expectations hypothesis has not been tested against UK evidence. Expectations of firms in the UK manufacturing sector are examined using data from the CBI Anticipations Survey, which provides direct observations on price and quantity expectations that can be separated by type of industry and size of firm. The data were gathered via questionnaires sent to 4,500 UK manufacturing firms 3 times a year from 1958 to 1971. If expectations are rational, then the rate of change equals the expected rate of change plus error. It is not appropriate, on the basis of a regression equation to analyze the UK economy as if manufacturing firms formed their expectations according to the rational expectations hypothesis. Results indicate that the rational expectations model is rejected more than it is accepted. Capacity formation has not adjusted correctly to price signals to achieve equilibrium between long-run supply and demand. Both supply and demand are inelastic to price changes.