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Escaping Nash inflation

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  • Cho, In-Koo
  • Sargent, Thomas J.

Abstract

Mean dynamics govern convergence to rational expectations equilibria of self-referential systems under least squares learning. We highlight escape dynamics that propel away from a rational expectations equilibrium under fixed-gain recursive learning schemes. These learning schemes discount past observations. In a model with a unique self-confirming equilibrium, we show that the destination of the escape dynamics is an outcome associated with government discovery of too strong a version of the natural rate hypothesis. That destination is not sustainable as a self-confirming equilibrium but is visited recurrently. The escape route dynamics cause recurrent outcomes close to the Ramsey (commitment) inflation rate in a model with an adaptive government. JEL Classification: E3, E52, E58

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Paper provided by European Central Bank in its series Working Paper Series with number 0023.

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Date of creation: Jun 2000
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Handle: RePEc:ecb:ecbwps:20000023

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  1. Cho, In-Koo & Matsui, Akihiko, 1995. "Induction and the Ramsey policy," Journal of Economic Dynamics and Control, Elsevier, vol. 19(5-7), pages 1113-1140.
  2. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  3. Albert Marcet & Juan P. Nicolini, 2003. "Recurrent Hyperinflations and Learning," American Economic Review, American Economic Association, vol. 93(5), pages 1476-1498, December.
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  7. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  8. 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.
  9. Wieland, Volker, 2000. "Learning by doing and the value of optimal experimentation," Journal of Economic Dynamics and Control, Elsevier, vol. 24(4), pages 501-534, April.
  10. Jeffrey C. Fuhrer, 1995. "The Phillips curve is alive and well," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 41-56.
  11. Sargent, Thomas J, 1971. "A Note on the 'Accelerationist' Controversy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(3), pages 721-25, August.
  12. White, Halbert, 1982. "Maximum Likelihood Estimation of Misspecified Models," Econometrica, Econometric Society, vol. 50(1), pages 1-25, January.
  13. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  14. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  15. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  16. Stokey, Nancy L, 1989. "Reputation and Time Consistency," American Economic Review, American Economic Association, vol. 79(2), pages 134-39, May.
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