Working Paper: NBER ID: w18348
Authors: Seonghoon Cho; Bennett T. McCallum
Abstract: This paper proposes forward convergence as a model refinement scheme for linear rational expectations (LRE) models and an associated no-bubble condition as a solution selection criterion. We relate these two concepts to determinacy and characterize the complete set of economically relevant rational expectations solutions to the LRE models under determinacy and indeterminacy. Our results show (1) why a determinate solution is economically meaningful in most, but not all, cases, and (2) that those models that are not forward-convergent have no economically relevant solutions.
Keywords: linear rational expectations; model refinement; determinacy; no-bubble condition
JEL Codes: C62; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Forward Convergence Condition (FCC) (C62) | Unique Stable Rational Expectations Equilibrium (REE) (C62) |
| Lack of Forward Convergence Condition (FCC) (C62) | Indeterminate or Economically Irrelevant Equilibria (D59) |
| Violation of No-Bubble Condition (NBC) (F65) | Lack of Economic Coherence in Solutions (D59) |