makes a forecasting error (as in incorrectly recording a value or mistyping), the stochastic shock will cause the agent to incorrectly forecast the price expectation level again even if the price level experiences no further shocks, since the previous expectations only ever incorporates part of their errors. The backward nature of expectation formulation and the resultant systematic errors made by agents (see cobweb model) had become unsatisfactory to economists such as John Muth, who was pivotal in the development of an alternative model of how expectations are formed, called rational expectations. The use of rational expectations have largely replaced adaptive expectations in macroeconomic theory since its assumptions rely on an optimal expectations approach which is consistent with economic theory. However, it must be stressed that confronting adaptive expectations and rational expectations aren't necessarily justified by either use, in other words, there are situations in which following the adaptive scheme is a rational response. The first use adaptive expectations hypothesis was to describe agent behavior in The Purchasing Power of Money by Irving Fisher (1911), then later used to describe models such as hyperinflation by Philip Cagan (1956). Adaptive expectations were instrumental in the consumption function (1957) and Phillips curve outlined by Milton Friedman. Friedman suggests that workers form adaptive expectations of the inflation rate, the government can easily surprise them through unexpected monetary policy changes. As agents are trapped by the money illusion, they are unable to correctly perceive price and wage dynamics, so based on Friedman's theory, unemployment can always be reduced through monetary expansions. If the government chooses to fix a low unemployment rate the result is an increasing level of inflation for an extended period of time. However, in this framework, it is clear why and how adaptive expectations are problematic. Agents are arbitrarily supposed to ignore sources of information which, otherwise, would affect their expectations. For example, government announcements are such sources. Agents are expected to modify their expectations and break with the former trends when changes in economic policy necessitate it. This is the reason why the theory of adaptive expectations is often regarded as a deviation from the rational tradition of economics. See also Policy ineffectiveness proposition Problem of induction Rational expectations Self-fulfilling prophecy Cobweb model Phillips curve Consumption function References General references George W. Evans and Seppo Honkapohja (2001), Learning and Expectations in Macroeconomics. Princeton University Press, ISBN 978-0-691-04921-2 Economic forecasting