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Uniqueness Of Bubble-Free Solution In Linear Rational Expectations Models

  • Desgranges, Gabriel
  • Gauthier, St phane

One usually identifies bubble solutions to linear rational expectations models by extra components (irrelevant lags) arising in addition to market fundamentals. Although there are still many solutions relying on a minimal set of state variables, i.e., relating in equilibrium the current state of the economic system to as many lags as initial conditions, there is a conventional wisdom that the bubble-free (fundamentals) solution should be unique. This paper examines the existence of endogenous stochastic sunspot fluctuations close to solutions relying on a minimal set of state variables, which provides a natural test for identifying bubble and bubble-free solutions. It turns out that only one solution is locally immune to sunspots, independently of the stability properties of the perfect-foresight dynamics. In the standard saddle-point configuration for these dynamics, this solution corresponds to the so-called saddle stable path.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 7 (2003)
Issue (Month): 02 (April)
Pages: 171-191

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Handle: RePEc:cup:macdyn:v:7:y:2003:i:02:p:171-191_01
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