Economically Sensible Solutions for Linear Rational Expectations Models with Forward and Backward Looking Dynamic Processes

27 Pages Posted: 12 Apr 2004

See all articles by Michael L. Mussa

Michael L. Mussa

International Monetary Fund (IMF) - Research Department; National Bureau of Economic Research (NBER)

Date Written: July 1984

Abstract

Using variants of a modified version of Dornbusch's model of price level and exchange rate dynamics, it is demonstrated that satisfaction of the formal condition for existence of a unigue non-explosive solution of a linear rational expectations model with forward and backward looking dynamic processes (equality of the number of stable roots with the number of independent backward looking processes) does not guarantee the economic sensibility of this solution, even if one accepts the usual arguments for excluding "speculative babbles" from the solutions of such models. Moreover, satisfaction of the formal condition for existence of an infinity of non-explosive solutions for such rational expectations models (more stable roots than independent backward looking processes) does not assure that any of these solutions is economically sensible.

Suggested Citation

Mussa, Michael L., Economically Sensible Solutions for Linear Rational Expectations Models with Forward and Backward Looking Dynamic Processes (July 1984). NBER Working Paper No. w1398, Available at SSRN: https://ssrn.com/abstract=324032

Michael L. Mussa (Contact Author)

International Monetary Fund (IMF) - Research Department

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National Bureau of Economic Research (NBER)

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