The theory of rational expectations concludes that

A) since expectations can cause discretionary stabilization policies to be pro-cyclical,it is better to rely upon policy rules.
B) discretionary monetary policy is a more powerful stabilization device than is discretionary fiscal policy.
C) discretionary fiscal policy is a more powerful stabilization device than is discretionary monetary policy.
D) discretionary policies are more effective than rules in stabilizing the economy.

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Batal Ahmed · Accepted Answer

Final Answer : A, Explanation :  The theory of rational expectations suggests that people have rational expectations about the future, including prices, wages, policies, and other economic variables. They use this information to make decisions, and therefore, their expectations can affect economic outcomes. If people expect that the government will pursue expansionary policies during a recession, for example, they may increase their spending, producing a self-fulfilling prophecy. This implies that discretionary stabilization policies can be pro-cyclical since they may amplify rather than dampen business cycles. As a result, it is better to rely on policy rules that guide economic decisions and reduce uncertainty. In particular, a rule-based monetary policy, such as inflation targeting, could help stabilize the economy in the long run.

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