Consistent Expectations, Rational Expectations, Multiple-Solution Indeterminacies, and Least-Squares Learnability

Bennett T. McCallum

NBER Working Paper No. 9218
Issued in September 2002
NBER Program(s):Economic Fluctuations and Growth, Monetary Economics

After some historical discussion of the rational expectations (RE) solution procedures of John Muth, Alan Walters, and Robert Lucas, this paper considers the relevance for actual economies of issues stemming from the existence of multiple RE equilibria. In all linear models, the minimum state variable (MSV) solution as defined by the author (JME, 1983) is unique by construction. While it might be argued that the MSV solution warrants special status as the bubble-free solution, the focus in this paper is on its adaptive, least-squares learnability by individual agents, as discussed extensively in important recent publications by George Evans and Seppo Honkapohja. Although the MSV solution is learnable and the main alternatives are not, in most standard models, Evans and Honkapohja have stressed an example in which the opposite is true. The present paper shows, however, that parameter values yielding that result are such that the model is not well formulated, in a specified sense (one that avoids implausible discontinuities). More generally, analysis of a pair of prominent univariate specifications, featured by Evans and Honkapohja, shows that the MSV solution is invariably learnable in these structures, if they are well formulated.

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Document Object Identifier (DOI): 10.3386/w9218

Published: Minford, Patrick (ed.) Money Matters: Essays in Honour of Alan Walters. Edward Elgar Publishing, 2004.

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