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Robust Learning Stability with Operational Monetary Policy Rules

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  • George W. Evans
  • Seppo Honkapohja
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    Abstract

    We consider “robust stability” of a rational expectations equilibrium, which we define as stability under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that for operational forms of policy rules, i.e. rules that do not depend on contemporaneous values of endogenous aggregate variables, many interest-rate rules do not exhibit robust stability. We consider a variety of interest-rate rules, including instrument rules, optimal reaction functions under discretion or commitment, and rules that approximate optimal policy under commitment. For some reaction functions we allow for an interest-rate stabilization motive in the policy objective. The expectations-based rules proposed in Evans and Honkapohja (2003, 2006) deliver robust learning stability. In contrast, many proposed alternatives become unstable under learning even at small values of the gain parameter.

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    File URL: http://www.st-andrews.ac.uk/economics/CDMA/papers/cp0808.pdf
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    Bibliographic Info

    Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Conference Paper Series with number 0808.

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    Handle: RePEc:san:cdmacp:0808

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    Postal: Department of Economics, University of St. Andrews, Fife KY16 9AL
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    Related research

    Keywords: Commitment; interest-rate setting; adaptive learning; stability; determinacy.;

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    References

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    1. Evans, G.W. & Guesnerie, R., 1992. "Rationalizability, Strong Rationality and Expectational Stability," DELTA Working Papers 92-03, DELTA (Ecole normale supérieure).
    2. John Duffy & Wei Xiao, 2006. "The Value of Interest Rate Stabilization Policies When Agents are Learning," Working Papers 284, University of Pittsburgh, Department of Economics, revised Oct 2006.
    3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
    4. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 807-824.
    5. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
    6. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
    7. Evans, George W & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch," CEPR Discussion Papers 6640, C.E.P.R. Discussion Papers.
    8. Milani, Fabio, 2007. "Expectations, learning and macroeconomic persistence," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 2065-2082, October.
    9. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
    10. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, vol. 91(2), pages 158-166, May.
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