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Two-sided Learning in New Keynesian Models: Dynamics, (Lack of) Convergence and the Value of Information

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  • Christian Matthes

    ()

  • Francesca Rondina

    ()

Abstract

This paper investigates the role of learning by private agents and the central bank (two-sided learning) in a New Keynesian framework in which both sides of the economy have asymmetric and imperfect knowledge about the true data generating process. We assume that all agents employ the data that they observe (which may be distinct for different sets of agents) to form beliefs about unknown aspects of the true model of the economy, use their beliefs to decide on actions, and revise these beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of our model and derive its policy recommendations, particularly with respect to central bank communications. We demonstrate that two-sided learning can generate substantial increases in volatility and persistence, and alter the behavior of the variables in the model in a signifficant way. Our simulations do not converge to a symmetric rational expectations equilibrium and we highlight one source that invalidates the convergence results of Marcet and Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank's model is substantially mis-specified

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Bibliographic Info

Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 913.12.

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Length: 31
Date of creation: 01 Oct 2012
Date of revision:
Handle: RePEc:aub:autbar:913.12

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Keywords: : asymmetric information; learning; monetary policy;

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  1. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  2. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
  3. Martin Ellison & Martin Ellison & Alina Barnett, 2011. "Learning by Disinflating," Economics Series Working Papers 579, University of Oxford, Department of Economics.
  4. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
  5. George W. Evans & Seppo Honkapohja, 2004. "Adaptive learning and monetary policy design," Macroeconomics 0405008, EconWPA.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
  7. James B. Bullard & Stefano Eusepi, 2004. "Did the Great Inflation occur despite policymaker commitment to a Taylor rule?," Working Papers 2003-013, Federal Reserve Bank of St. Louis.
  8. Kaushik Mitra & Seppo Honkapohja, 2004. "Performance of Monetary Policy with Internal Central Bank Forecasting," Royal Holloway, University of London: Discussion Papers in Economics 04/18, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  9. Orphanides, Athanasios & Williams, John C, 2005. "The Decline of Activist Stabilization Policy: Natural Rate Misperceptions, Learning and Expectations," CEPR Discussion Papers 4865, C.E.P.R. Discussion Papers.
  10. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  11. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2005-11, University of Oregon Economics Department, revised 06 Apr 2005.
  12. Milani, Fabio, 2008. "Learning, monetary policy rules, and macroeconomic stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3148-3165, October.
  13. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  14. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  15. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
  16. William A. Brock & Steven N. Durlauf & James M. Nason & Giacomo Rondina, 2007. "Simple versus optimal rules as guides to policy," Working Paper 2007-07, Federal Reserve Bank of Atlanta.
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