Expectational Stability in Multivariate Models

This paper shows that the concept of Expectational stability (E-stability) in a multivariate framework is inherently model-dependent. Whereas a Rational Expectations equilibrium (REE) is subject to model-specific parameter restrictions from the economic model at hand, a perceived law of motion (PLM) is postulated without such restrictions because economic agents are not likely to know the restrictions a priori. Therefore, an unrestricted PLM is in general overparameterized relative to an REE of interest in multivariate models even when the functional form is the same as the REE. Since E-stability necessarily involves model-specific extents of overparameterization, it is model-dependent in general. An immediate implication is that E-stability in a multivariate framework is not directly comparable across models and, in particular, across different representations of a given model. This implies that one may draw different conclusions on E-stability of an REE to one model under alternative representations of the model and the REE. We discuss a potential direction to develop a model-independent concept of E-stability.