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Time-consistent decisions and rational expectation equilibrium existence in DSGE models

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  • Minseong Kim

Abstract

We demonstrate that if all agents in an economy make time-consistent decisions and policies, then there exists no rational expectation equilibrium in a dynamic stochastic general equilibrium (DSGE) model, unless under very restrictive and special circumstances. Some time-consistent interest rate rules, such as Taylor rule, worsen the equilibrium non-existence issue in general circumstances. Monetary policy needs to be lagged in order to avoid equilibrium non-existence due to agents making time-consistent decisions. We also show that due to the transversality condition issue, either fiscal-monetary coordination may need to be modeled, or it may be necessary to write a model such that bonds or money provides utility as medium of exchange or has liquidity roles.

Suggested Citation

  • Minseong Kim, 2019. "Time-consistent decisions and rational expectation equilibrium existence in DSGE models," Papers 1909.10915, arXiv.org, revised Nov 2019.
  • Handle: RePEc:arx:papers:1909.10915
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    File URL: http://arxiv.org/pdf/1909.10915
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    1. Time-consistent decisions and rational expectation equilibrium existence in DSGE models
      by Christian Zimmermann in NEP-DGE blog on 2019-10-23 19:10:02

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