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Learning the Ramsey outcome in a Kydland & Prescott economy

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  • Arifovic, Jasmina
  • Yıldızoğlu, Murat

Abstract

We study if adaptive learning by a Central Bank (CB) in the Kydland and Prescott environment can steer the economy to the Pareto-optimal outcome. Our CB evaluates its potential strategies regarding the announced and the actual inflation rate through expectations of the performance of these strategies, formed thanks to its mental model of the economy. This model is forward looking and adaptive at the same time. As a starting point, we follow Arifovic et al. (2010), and initially assume that there are two types of agents: Believers who set their inflation forecast equal to the announced inflation, and Non-believers who form static optimal forecast coupled with a forecast error correction mechanism. Our results show that the economy can reach near Ramsey outcomes most of the time. In the absence of Believers, the economies almost always converge to the Ramsey outcome.

Suggested Citation

  • Arifovic, Jasmina & Yıldızoğlu, Murat, 2019. "Learning the Ramsey outcome in a Kydland & Prescott economy," Journal of Economic Behavior & Organization, Elsevier, vol. 157(C), pages 191-208.
    • Handle: RePEc:eee:jeborg:v:157:y:2019:i:c:p:191-208
    DOI: 10.1016/j.jebo.2017.11.001
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    More about this item

    Keywords

    Learning in the Kydland–Prescott environment; Expectations; Artificial neural networks; Credibility of economic policies; Convergence to Nash equilibrium; Ramsey outcome;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D60 - Microeconomics - - Welfare Economics - - - General

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