Discretionary Policy and Multiple Equilibria in LQ RE Models

Abstract

We study stationary discretionary equilibria in dynamic linear-quadratic rational expectations models. Past papers have assumed that this is uniquely determined; we show that such models can have multiple equilibria in some situations. We demonstrate the existence of multiple discretionary equilibria using a number of examples of increasing complexity, and discuss their potential to explain interesting economic phenomena. We investigate the general properties of discretionary equilibria and discuss the design implications for the numerical algorithms needed to find them.

Keywords: Time Consistency, Discretion, Multiple Equilibria, LQ RE models

JEL Classification: E31, E52, E58, E61, C61