7 According to the rational expectations hypothesis, people will

(a) comprehend the impact of macropolicy changes on prices and employment and

(b) adjust their choices accordingly and rapidly. For example, when confronting an expansionary macropolicy, lenders will demand higher interest rates, union representatives higher money wage rates, and business firms higher prices on long-term contractual sales. According to the rational expectations theory, these actions will cause the inflation rate to rise almost immediately while largely offsetting the employment and output effects of the expansionary policy.