Working Paper: NBER ID: w0684
Authors: Bennett T. McCallum
Abstract: Many macroeconomic models involving rational expect at ions give rise to an infinity of solution paths, even when the models are linear in all variables. Some writers have suggested that this non-uniqueness constitutes a serious weakness for the rational expectations hypothesis. One purpose of the present paper is to argue that the non-uniqueness in question is not properly attributable to the rationality hypothesis but, instead, is a general feature of dynamic models involving expectations. It is also argued that there typically exists, in a very wide class of linear rational expectations models, a single solution that excludes "bubble" or "bootstrap" effects -- ones that occur only because they are arbitrarily expected to occur. A systematic procedure for obtaining solutions free from such effects is introduced and discussed. In addition, this procedure is used to interpret and reconsider several prominent examples with solution multiplicities, including ones developed by Fischer Black and John B. Taylor.
Keywords: Rational Expectations; Solution Multiplicity; Dynamic Models
JEL Codes: E30; E40; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| multiplicity of solutions (C30) | rational expectations hypothesis (D84) |
| systematic procedure (C90) | unique rational expectations solution (D84) |
| unique rational expectations solution (D84) | validity of rational expectations hypothesis (D84) |
| multiplicity of solutions (C30) | systematic procedure (C90) |
| undetermined coefficients (C29) | unique solution (C29) |
| minimal set of state variables (C29) | unique solution (C29) |
| proposed methodology (C80) | elimination of multiplicity of solutions (C30) |