We demonstrate that if all agents in an economy make time-consistent decisions and policies, then there exists no rational expectation equilibrium in a dynamic stochastic general equilibrium (DSGE) model, unless under very restrictive and special circumstances. Some time-consistent interest rate rules, such as Taylor rule, worsen the equilibrium non-existence issue in general circumstances. Monetary policy needs to be lagged in order to avoid equilibrium non-existence due to agents making time-consistent decisions. We also show that due to the transversality condition issue , either fiscal-monetary coordination may need to be modeled, or it may be necessary to write a model such that bonds or money provides utility as medium of exchange or has liquidity roles .
Under some initial conditions, it is shown that time consistency requirements prevent rational expectation equilibrium (REE) existence for dynamic stochastic general equilibrium models induced by consumer heterogeneity, in contrast to static models. However, one can consider REE-prohibiting initial conditions as limits of other initial conditions. The REE existence issue then is overcome by using a limit of economies. This shows that significant care must be taken of when dealing with rational expectation equilibria .
R
We demonstrate that if all agents in an economy make time-consistent decisions and policies, then there exists no
Under some initial conditions, it is shown that time consistency requirements prevent
R
in a
(REE) existence for
R
(DSGE) model, unless under very restrictive and special circumstances. Some time-consistent interest rate rules, such as Taylor rule, worsen the equilibrium non-existence issue in general circumstances. Monetary policy needs to be lagged in order to avoid equilibrium non-existence due to agents making time-consistent decisions. We also show that due to the transversality condition issue , either fiscal-monetary coordination may need to be modeled, or it may be necessary to write a model such that bonds or money provides utility as medium of exchange or has liquidity roles
models induced by consumer heterogeneity, in contrast to static models. However, one can consider REE-prohibiting initial conditions as limits of other initial conditions. The REE existence issue then is overcome by using a limit of economies. This shows that significant care must be taken of when dealing with rational expectation equilibria