Dynamic Equivalence Principle In Linear Rational Expectations Models
AbstractLinear models with infinite horizon generally admit infinitely many rational expectations solutions. Consequently, some additional selection devices are needed to narrow the set of relevant solutions. The viewpoint of this paper is that a solution will be more likely to arise if it is locally determinate (i.e., locally isolated), locally immune to sunspots, and locally stable under learning. These three criteria are applied to solutions of linear univariate models along which the level of the state variable evolves through time. In such models the equilibrium behavior of the level of the state variable is described by a linear recursive equation characterized by the set of its coefficients. The main innovation of this paper is to define new perfect-foresight dynamics whose fixed points are these sets of coefficients, thus allowing us to study the property of determinacy of these sets, or, equivalently, of the associated solutions. It is shown that only one solution is locally determinate in the new dynamics. It is also locally immune to sunspots and locally stable under myopic learning. This solution corresponds to the saddle path in the saddle-point case.
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Bibliographic InfoArticle provided by Cambridge University Press in its journal Macroeconomic Dynamics.
Volume (Year): 7 (2003)
Issue (Month): 01 (February)
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Other versions of this item:
- Stéphane Gauthier, 2003. "Dynamic equivalence principle in linear rational expectations models," Post-Print halshs-00069499, HAL.
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- McCallum, Bennett T., 2004. "On the relationship between determinate and MSV solutions in linear RE models," Economics Letters, Elsevier, vol. 84(1), pages 55-60, July.
- Bennett McCallum, . "On the Relationship Between Determinate and MSV Solutions in Linear RE Models," GSIA Working Papers 2003-E78, Carnegie Mellon University, Tepper School of Business.
- Roger Guesnerie, 2006. "General equilibrium, coordination and multiplicity on spot markets," Working Papers halshs-00590540, HAL.
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