The government behavioural constraint in rational expectations models

Nobay, A.R. and Peel, David (1982) The government behavioural constraint in rational expectations models. Economics Letters, 9 (3). pp. 221-227. ISSN 0165-1765

Abstract

Models with rationalexpectations typically include state variables whose values are controlled by the government. Hence, the need to specify behavioural rules for the authorities. Our purpose is to show, in the context of a well-known Cagan type model of the demand for money, that the assumption of rationalexpectations imposes the hitherto neglected requirement of rationality of the postulated behaviour of government. In particular the occurance of non-unique solutions highlights the need for a rational choice between these on grounds other than mathematical convenience or ad hoc economic assumptions of minimum variance, terminal conditions etc.