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Role of the Minimal State Variable Criterion

  • Bennett T. McCallum

This paper concerns the minimal-state-variable (MSV) criterion for selection among solutions in rational expectations (RE) models that feature a multiplicity of paths that satisfy all of the model's conditions. It compares the MSV criterion with others that have been proposed, including the widely used saddle-path (or dynamic stability) criterion. It is emphasized that the MSV criterion can be viewed as a classification scheme that delineates the unique solution that is free of bubble or sunspot components. This scheme is of scientific value as it (a) yields a single solution upon which a researcher can focus attention if desired and (b) provides the basis for a substantive hypothesis that actual market outcomes are generally of a bubble-free nature. In the process of demonstrating uniqueness of the MSV solution for a broad class of linear models, the paper exposits a convenient and practical computational procedure. Also, several applications to current issues regarding monetary policy are outlined.

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File URL: http://www.nber.org/papers/w7087.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7087.

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Date of creation: Mar 2000
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Publication status: published as International Tax and Public Finance, vol 6, no. 4, pp. 621-639, 1999.
Handle: RePEc:nbr:nberwo:7087
Note: ME EFG
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  1. Flood, Robert P & Garber, Peter M, 1980. "An Economic Theory of Monetary Reform," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 24-58, February.
  2. Jo Anna Gray, 1982. "Dynamic instability in rational expectations models: an attempt to clarify," International Finance Discussion Papers 197, Board of Governors of the Federal Reserve System (U.S.).
  3. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  4. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  5. Svensson, Lars E O, 1998. "Inflation Targeting as a Monetary Policy Rule," CEPR Discussion Papers 1998, C.E.P.R. Discussion Papers.
  6. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-214, December.
  7. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  8. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  9. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  10. Binder, Michael & Pesaran, M. Hashem, 1997. "Multivariate Linear Rational Expectations Models," Econometric Theory, Cambridge University Press, vol. 13(06), pages 877-888, December.
  11. Maurice Obstfeld & Kenneth Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
  12. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  13. Burmeister, Edwin & Flood, Robert P. & Garber, Peter M., 1983. "On the equivalence of solutions in rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 5(1), pages 311-321, February.
  14. Bennett T. McCallum & Edward Nelson, . "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
  15. Brock, William A., 1975. "A simple perfect foresight monetary model," Journal of Monetary Economics, Elsevier, vol. 1(2), pages 133-150, April.
  16. Evans, George W & Honkapohja, Seppo, 1992. "On the Robustness of Bubbles in Linear RE Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 33(1), pages 1-14, February.
  17. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  18. Evans, George W., 1989. "The fragility of sunspots and bubbles," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 297-317, March.
  19. repec:dgr:kubcen:199597 is not listed on IDEAS
  20. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  21. Taylor, John B, 1977. "Conditions for Unique Solutions in Stochastic Macroeconomic Models with Rational Expectations," Econometrica, Econometric Society, vol. 45(6), pages 1377-85, September.
  22. Evans, George, 1985. "Expectational Stability and the Multiple Equilibria Problem in Linear Rational Expectations Models," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1217-33, November.
  23. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
  24. McCallum, Bennett T., 1998. "Solutions to linear rational expectations models: a compact exposition," Economics Letters, Elsevier, vol. 61(2), pages 143-147, November.
  25. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, December.
  26. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
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