Role of the Minimal State Variable Criterion

35 Pages Posted: 30 Jul 1999 Last revised: 8 May 2000

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Date Written: March 2000

Abstract

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.

Suggested Citation

McCallum, Bennett T., Role of the Minimal State Variable Criterion (March 2000). NBER Working Paper No. w7087, Available at SSRN: https://ssrn.com/abstract=162968

Bennett T. McCallum (Contact Author)

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