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Abstract

This paper investigates the role of learning by both private agents and the central bank (two-sided learning) in a New Keynesian framework populated by private agents and a central bank that have asymmetric imperfect knowledge about the true data generating process. We assume that all agents employ the data they observe (which can be different for different sets of agents) to form beliefs about the aspects of the true model of the economy that they do not know, use these beliefs to decide on actions, and revise beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of the model and policy recommendations coming out of our model, in particular concerning central bank communication. Two-sided learning can generate large increases in volatility and persistence, and can alter the behavior of the variables in the model in a significant way. We also show that our model does not converge to a symmetric rational expectations equilibrium and highlight one source that disables the convergence results of Marcet & Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank’ model is substantially misspecified.

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Bibliographic Info

Paper provided by CEPREMAP in its series Dynare Working Papers with number 19.

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Length: 30 pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:cpm:dynare:019

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Find related papers by JEL classification:

• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

This paper has been announced in the following NEP Reports:

• NEP-ALL-2013-01-07 (All new papers)
• NEP-CTA-2013-01-07 (Contract Theory & Applications)

References

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1. Evans, George W & Honkapohja, Seppo, 2002. "Monetary Policy, Expectations and Commitment," CEPR Discussion Papers 3434, C.E.P.R. Discussion Papers.
   
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2. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
   
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   • George W. Evans & Seppo Honkapohja, 2002. "Adaptive Learning and Monetary Policy Design," University of Oregon Economics Department Working Papers 2002-18, University of Oregon Economics Department, revised 04 Mar 2004.
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3. Orphanides, Athanasios & Williams, John C., 2005. "The decline of activist stabilization policy: Natural rate misperceptions, learning, and expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 1927-1950, November.
   
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   • 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.
   • Athanasios Orphanides & John C. Williams, 2004. "The decline of activist stabilization policy: Natural rate misperceptions, learning and expectations," Working Paper Series 337, European Central Bank.
4. 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, vol. 54(5), pages 1372-1396, July.
   
   • 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.
5. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
   
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6. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
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8. Barnett, Alina & Ellison, Martin, 2012. "Learning by disinflating," Research Discussion Papers 10/2012, Bank of Finland.
9. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
   
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10. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
    
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11. 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.
    
    • Honkapohja, Seppo & Mitra, Kaushik, 2005. "Performance of monetary policy with internal central bank forecasting," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 627-658, April.
    • Seppo Honkapohja & Kaushik Mitra, 2002. "Performance of monetary policy with nternal Central Bank forecasting," Working Paper Series 127, European Central Bank.
    • Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers 3/2002, Bank of Finland.
12. 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.
    
    • James Bullard & Stefano Eusepi, 2005. "Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 324-359, April.
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    • James Bullard & Stefano Eusepi, 2003. "Did the Great Inflation occur despite policymaker commitment to a Taylor rule?," Working Paper 2003-20, Federal Reserve Bank of Atlanta.
13. Martin Ellison & Martin Ellison & Alina Barnett, 2011. "Learning by Disinflating," Economics Series Working Papers 579, University of Oxford, Department of Economics.
14. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
    
    • Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
15. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
    
    • Evans, George W & Honkapohja, Seppo, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Wiley Blackwell, vol. 65(1), pages 23-44, January.
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    • Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.

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