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14.462

Problem set 4

pt = αpet+1 + εt

e

Where pt is the endogenous variable (say an asset price), pt+1 its expected value,

2

and εt an iid shock with zero mean and variance σ , which is not known a period

ahead.

1. What is the rational expectations equilibrium (REE)?

Assume that instead of rational expectations, we have a learning process

deﬁned by

1

pet+1 = pte + (pt−1 − pte ),

gt

where gt is a deterministic sequence of strictly positive numbers/

We will say that the learning process converges to the REE if

t→+∞

where E is the unconditional expectations operator, and Et,REE pt+1 is the value

of pet+1 in the rational expectations equilibrium, given the history of shocks.

2. Show that a necessary and suﬃcient condition for convergence to the

REE is

lim mt = 0, (1)

t−→+∞

where

t

� h2 ...h2

1 s t

mt = 2 + 2 ,

gt s=1

g s−1

and

ht = 1 + (α − 1)/gt .

3. Show that mt satisﬁes

2

(2)

α < 1

lim gt = +∞

and

t

�

lim ht = 0

s=0

1

https://www.economicshomeworkhelper.com

5. Show that the latter condition is asymptotically equivalent to

+∞

�

1/gt = +∞.

0

gt = 1/(t + 1)2 ?

7. Assume gt = 1/(t + 1). Show that (1) is satisﬁed (hint: use (2) and look

for β > 0 such that one can show by induction that mt < At−β for t large

enough).

8. Intuitively, what are the problems if gt converges ”too fast” or ”too

slowly” to inﬁnity?

2

14.462 Advanced Macroeconomics

Spring 2004

1. It is easy to check that pt = εt is the (bubbleless) REE equilibrium. Next consider the

learning process. Substituting the model equation into the learning equation yields

1 εt−1

pet+1 = pte + (αpte + εt−1 − pet ) = ht pet + .

gt gt

By induction one obtain

t

� �t+1 t

εs−2 �

pet+1 = p0e hs +

hτ

s=0 s=1

g s−1 τ =s

Using this formula and the fact that the εt are iid, we can compute

�t t+1

� t t

�

�

2 1

� 2 �

E

pet+1 − Et,REE pt+1 = (pe0 )2 h2s + σ 2 2

h τ = (p e 2

0 ) h2s + σ 2 m

t

s=0

g

s=1 s−1 τ =s s=0

�t

2. Necessity is obvious. To show suﬃciency notice that mt ≥ τ =1 h2τ , so limt→∞ mt = 0

insures that the term in front of pe0 vanishes as t → ∞.

3. We have

1

h2t+1 mt + 2

gt+1

t+1

� t t+1 t+1 t+2 t+1

1 � 1 � 1

� 2 1 � 1

� 2

= h2t+1 2

h2τ + 2

=

hτ + 2 =

hτ = mt+1

s=1

gs−1 τ =s

gt+1 g2

s=1 s−1 τ =s

gt+1 g2

s=1 s−1 τ =s

4. First notice that mt ≥ g12 so limt→∞ mt = 0 clearly requires that limt→∞ gt = +∞.

�t t

Also mt ≥ g21 2

τ =s τ for all s ∈ {1, . . . , t + 1}. It follows that limt→∞ mt = 0

h

s−1

requires

�t

lim hτ = 0

t→∞

τ =s

for all s ≥ 1, which is stronger than the requirement stated in the problem set since

it must hold for all s ≥ 1. Finally if α ≥ 1, then ht ≥ 1 for all t which is inconsistent

�

with limt→∞ tτ =s hτ = 0. Thus it must be the case that α < 1.

1

5. Suppose

t

�

lim hτ = 0

t→∞

τ =s

�+∞ 1

for all s ≥ 1. The goal is to show that 0 gt

= +∞.

6. Pick T such that t ≥ T implies 1−α < 12 and deﬁne an = g1−α for n ≥ 0. We want to

�∞ qt �∞ T +n

show that n=0 (1 − an ) = 0 if and only if n=0 an = +∞. This follows from some

results on convergence of inﬁnite products,. see the book Mathematical Analysis, 2ed

by Apostol, pp. 206–209. One direction is not so diﬃcult: as 1 − an ≤ e−an , we have

�∞ �∞

− n=0 an

n=0 (1 − an ) ≤ e . At least to me it seems that the other direction is a bit

more involved, but perhaps you found an easy proof. Otherwise take a look at the

book by Apostol.

1

�+∞ 1

7. If gt is a constant, then limt→∞ gt = +∞ fails. If gt = (t+1) 2 , then 0 gt

= +∞

fails.

8.

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