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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 significant 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 Barcelona Graduate School of Economics in its series Working Papers with number 661.

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Date of creation: Sep 2012
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Handle: RePEc:bge:wpaper:661

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Keywords: asymmetric information; learning; monetary policy;

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  1. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers, Bank of Finland 29/2002, Bank of Finland.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Jun.
  3. Orphanides, Athanasios & Williams, John C., 2004. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Working Paper Series, European Central Bank 0337, European Central Bank.
  4. James Bullard & Stefano Eusepi, 2003. "Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?," Computing in Economics and Finance 2003, Society for Computational Economics 129, Society for Computational Economics.
  5. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers, Federal Reserve Bank of St. Louis 2000-001, Federal Reserve Bank of St. Louis.
  6. Brock, William A. & Durlauf, Steven N. & Nason, James M. & Rondina, Giacomo, 2007. "Simple versus optimal rules as guides to policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(5), pages 1372-1396, July.
  7. Stefano Eusepi & Bruce Preston, 2010. "Central Bank Communication and Expectations Stabilization," American Economic Journal: Macroeconomics, American Economic Association, American Economic Association, vol. 2(3), pages 235-71, July.
  8. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2006. "Adaptive Learning in Practice," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5627, C.E.P.R. Discussion Papers.
  9. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series, European Central Bank 0127, European Central Bank.
  10. Evans, George W & Honkapohja, Seppo, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 65(1), pages 23-44, January.
  11. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  12. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports, Federal Reserve Bank of New York 524, Federal Reserve Bank of New York.
  13. Milani, Fabio, 2008. "Learning, monetary policy rules, and macroeconomic stability," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(10), pages 3148-3165, October.
  14. Alina Barnett & Martin Ellison, 2013. "Learning by Disinflating," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 45(4), pages 731-746, 06.
  15. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
  16. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, American Economic Association, vol. 92(5), pages 1521-1534, December.
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