Abstract
We motivate and provide proofs of Ba?ar and Olsder’s (1995) theorems on the subject. The context is the increasing appreciation that the neoclassical framework is not the only model of the economy.
Highlights
The longstanding critique of the Dynamic Stochastic General Equilibrium (DSGE) model has gained widespread publicity as a consequence of the recent financialreal meltdown [1]
If agents access all the information they can command and the economy is described by a dynamic general equilibrium model, there is no incentive for any player to ‘cheat’ on the equilibrium
If, under the same information conditions, the economy is characterized by a Keynesian model, agents will be locked into a “bad” equilibrium
Summary
The longstanding critique of the Dynamic Stochastic General Equilibrium (DSGE) model has gained widespread publicity as a consequence of the recent financialreal meltdown [1]. Of interest to us are an assumption and a theorem. The assumption of rational expectations is that agents access all available information. DSGE theorems leave no room for inefficient outcomes. An outcome might be a Keynes equilibrium like involuntary unemployment. A Nash equilibrium in the inflation rate will exist in the present. In any following period, the MA has an incentive to generate a higher rate of inflation in order to stimulate activity. The economy will tend to the natural rate of unemployment with the higher rate of inflation. The task is to remove discretion from the MA and subject monetary policy committees to rules. We exploit the distinction to show, under specified conditions, that discretion is not inferior to rules
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