Expectations are based on all available information, not just past information but also predictions about current and future policy. Gathering information about the economy is costly. People will not have complete knowledge, but people will use the information they do have including predictions about the future. People may make mistakes in predictions but will adjust expectations to policy changes. People will not make systematic mistakes .
Errors tend to be random.
As the Fed in period 2, people anticipate changes in prices. Thus, their price expectations change, which shifts SRPC 1 to SRPC 2 leaving U unchanged at U N . Any systematic Fed policy will not be able to change U if people have rational expectations. In the example above people did notmake sytematic mistakes. Since expectations are adaptive, the shift in AD is along a stable SRAS 0 .