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Learning, Inflation Cycles, and Depression

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  • Ryo Horii

    ()
    (Graduate School of Economics, Osaka University)

  • Yoshiyasu Ono

    ()
    (Institute of Social and Economic Research, Osaka University)

Abstract

This paper constructs a model that describes inflation cycles and prolonged depression as generated by the learning behavior of households who face a random liquidity shock in which money is needed. Households update the subjective probability of the shock based on the observation and change their liquidity preference accordingly. In this setting, we first derive a stationary cycles under perfect price adjustment, which is characterized by periods of gradual inflation and sudden sporadic falls of the price level. When the nominal stickiness is introduced, the liquidity shock is followed by a period of depression in which unemployment exists and deflation occurs gradually. Depression is deep and prolonged when the economy has experienced a long period of boom before encountering a liquidity shock.

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File URL: http://www2.econ.osaka-u.ac.jp/library/global/dp/0614.pdf
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Bibliographic Info

Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 06-14.

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Length: 28 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:osk:wpaper:0614

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Web page: http://www.econ.osaka-u.ac.jp/
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Related research

Keywords: Bayesian Learning in Continuous Time; Hamilton-Jacobi-Bellman Equations; Markov Modulated Poisson Processes; Partial Delay Differential Equations; Liquidity Preference.;

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References

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  1. Potter Simon M., 2000. "A Nonlinear Model of the Business Cycle," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 4(2), pages 1-11, July.
  2. David Andolfatto & Paul Gomme, 1997. "Monetary Policy Regimes and Beliefs," Working Papers 97002, University of Waterloo, Department of Economics, revised Jan 1997.
  3. Keith Sill & Jeff Wrase, 1999. "Exchange rates, monetary policy regimes, and beliefs," Working Papers 99-6, Federal Reserve Bank of Philadelphia.
  4. Ryo Horii & Yoshiyasu Ono, 2005. "Financial Crisis and Recovery: Learning-based Liquidity Preference Fluctuations," Macroeconomics 0504016, EconWPA.
  5. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  6. Lee, I.H. & Chalkley, M., 1994. "Asymmetric business cycles," Discussion Paper Series In Economics And Econometrics 9411, Economics Division, School of Social Sciences, University of Southampton.
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