UNIQUENESS OF BUBBLE-FREE SOLUTION IN LINEAR RATIONAL EXPECTATIONS MODELS

Gabriel Desgranges and Stephane Gauthier

Macroeconomic Dynamics, 2003, vol. 7, issue 2, 171-191

Abstract: One usually identifies bubble solutions to linear rational expectations models by extra components (irrelevant lags) arising in addition to market fundamentals. Although there are still many solutions relying on a minimal set of state variables, i.e., relating in equilibrium the current state of the economic system to as many lags as initial conditions, there is a conventional wisdom that the bubble-free (fundamentals) solution should be unique. This paper examines the existence of endogenous stochastic sunspot fluctuations close to solutions relying on a minimal set of state variables, which provides a natural test for identifying bubble and bubble-free solutions. It turns out that only one solution is locally immune to sunspots, independently of the stability properties of the perfect-foresight dynamics. In the standard saddle-point configuration for these dynamics, this solution corresponds to the so-called saddle stable path.

Date: 2003
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Related works:
Working Paper: Uniqueness of bubble-free solution in linear rational expectations models (2003)
Working Paper: On the Uniqueness of the Bubble-Free Solution in Linear Rational Expectations Models (1999)
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