On the Mathematical Basis of Inter-temporal Optimization
Almost no economic time series is either weakly or strictly stationary: distributions of economic variables shift over time. Thus, the present treatment of expectations in economic theories of inter-temporal optimization is inappropriate. It cannot be proved that conditional expectations based on the current distribution are minimum mean-square error 1-step ahead predictors when unanticipated breaks occur, and consequentially, the law of iterated expectations then fails inter-temporally. A second consequence is that dynamic stochastic general equilibrium models are intrinsically non-structural.
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