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Logical Pitfalls of Assuming Bounded Solutions to Expectational Difference Equations

David Eagle () and Elizabeth Murff
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Elizabeth Murff: Eastern Washington University

GE, Growth, Math methods from University Library of Munich, Germany

Abstract: The precedent for solving expectational difference equations has been to solve converging equations backwards and diverging equations forward by assuming the solution is bounded. This precedent often leads to incorrect solutions and has less than rigorous foundations. More rigorous procedures would be to determine the terminal condition in a finite model and take the limit of that terminal condition as the horizon goes to infinity. Also, whether one solves forward or backwards depends on the context of the difference equation, not on convergence or divergence. These new procedures reveal Woodford’s (2003) model of a cashless economy to be incomplete.

Keywords: expectational difference equations; infinite horizons; Woodford's cashless economy; price indeterminacy; pegging interest rates (search for similar items in EconPapers)
JEL-codes: E10 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2005-01-20
Note: Type of Document - pdf. Shows limitations of Sargent's precedent for solving expectational difference equations. It also shows Woodford's use of Sargent's precedent to be inappropriate.
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