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Two-sided learning in New Keynesian models: Dynamics, (lack of) convergence and the value of information

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  • Christian Matthes
  • Francesca Rondina

Abstract

This paper investigates the role of learning by private agents and the central bank (two-sided learning) in a New Keynesian framework in which both sides of the economy have asymmetric and imperfect knowledge about the true data generating process. We assume that all agents employ the data that they observe (which may be distinct for different sets of agents) to form beliefs about unknown aspects of the true model of the economy, use their beliefs to decide on actions, and revise these beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of our model and derive its policy recommendations, particularly with respect to central bank communications. We demonstrate that two-sided learning can generate substantial increases in volatility and persistence, and alter the behavior of the variables in the model in a significant way. Our simulations do not converge to a symmetric rational expectations equilibrium and we highlight one source that invalidates the convergence results of Marcet and Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank's model is substantially mis-specified.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1338.

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Date of creation: Sep 2012
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Handle: RePEc:upf:upfgen:1338

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Web page: http://www.econ.upf.edu/

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Keywords: asymmetric information; learning; monetary policy;

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  1. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers 3/2002, Bank of Finland.
  2. John C. Williams & Athanasios Orphanides, 2004. "The Decline of Activist Stabilization Policy: Natural Rate Misperceptions, Learning, and Expectations," Computing in Economics and Finance 2004 144, Society for Computational Economics.
  3. Barnett, Alina & Ellison, Martin, 2012. "Learning by disinflating," Research Discussion Papers 10/2012, Bank of Finland.
  4. 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.
  5. Chryssi Giannitsarou & Eva Carceles-Poveda, 2004. "Adaptive Learning in Practice," Computing in Economics and Finance 2004 271, Society for Computational Economics.
  6. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," Discussion Papers 0708-10, Columbia University, Department of Economics.
  7. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  8. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  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. Milani, Fabio, 2008. "Learning, monetary policy rules, and macroeconomic stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3148-3165, October.
  11. George W. Evans & Seppo Honkapohja, 2004. "Adaptive learning and monetary policy design," Macroeconomics 0405008, EconWPA.
  12. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  13. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  14. 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.
  15. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
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