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RATIONALITY OF BELIEFS AND MODEL CONSISTENCY

Published online by Cambridge University Press:  01 March 2008

Miroslav Misina
Miroslav Misina*
Affiliation:
Bank of Canada
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Abstract

The assumption of rational expectations (RE) plays two roles in economic models: it imposes restrictions on behaviour of agents, and it ensures model consistency. Dissatisfaction with RE on behavioural grounds has, in a variety of models, led to its replacement by more behaviourally plausible postulates. However, replacing RE by ad hoc behavioural postulates may result in internally inconsistent models. This work introduces a conceptual framework within which the nature of the issue can be described, and points to potential problems that the abandonment of RE entails. We argue that the RE-based notion of consistency is model-specific rather than general, and introduce a weaker consistency condition that is relevant for non-RE models. To assess the consistency of these models, we propose a test and illustrate its use taking an example from the recent literature. Broader implications of the findings are discussed.

Type
Essay
Information
Economics & Philosophy , Volume 24 , Issue 1 , March 2008 , pp. 65 - 79
Copyright
Copyright © Cambridge University Press 2008

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References

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