On the Mathematical Basis of Inter-temporal Optimization

Almost no economic time series is either weakly or strictly stationary: distributions of economic variables shift over time. Thus, the present treatment of expectations in economic theories of inter-temporal optimization is inappropriate. It cannot be proved that conditional expectations based on… the current distribution are minimum mean-square error 1-step ahead predictors when unanticipated breaks occur, and consequentially, the law of iterated expectations then fails inter-temporally. A second consequence is that dynamic stochastic general equilibrium models are intrinsically non-structural.