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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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.
Find related papers by JEL classification: D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
David Andolfatto & Paul Gomme, 2003.
"Monetary Policy Regimes and Beliefs,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 1-30, February.
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