Time-consistent decisions and rational expectation equilibrium existence in DSGE models

Abstract

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.

v4. Some corrections and interpretation-wise change in response to different comments