‘ING BUBBLES rinflations in Optimizing Models

Rational expectations macroeconomic models frequently possess an embarrassingly large number of equilibria. One of these equilibria is the familiar neoclassical solution in which t1 e price level grows at the rate of monetary expansion but there are others in which the price level is either explosive or implosive even in models with a constant nominal supply of money. Under certain conditions it is possible to appeal to transversality conditions in order to rule out implosive price paths [Brock (1974), Brock and Scheinkman (1980)]. but conditions which have previously been suggested in order to rule out hyperinflations are excessively restrictive and do not arise naturally as a result of the technological properties of a monetary economy.’ In contrast, this paper demonstrates that in order to rule out speculative bubbles it is sufficient that goods come in discrete units. Along an explosive price path the value of real money balances must fall over time but the discrete nature of the economy implies that the value of money will reach zero in finite time. Since money is held only because of its future value in transactions, no agent will hold money in period t which is known to be worthless in period t + 1 and an explosive price path cannot be an equilibrium.