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Learning under fear of floating

  • Bigio, Saki

In recent years a large fraction of economies overcame the fear of floating. We study a model that describes the policy of a Central Bank uncertain about whether currency depreciations cause output to expand (textbook model) or contract (balance-sheet model). We conclude that the movement away from fear of floating may not be explained by Bayesian or Robust policies. When the private sector anticipates the Central Bank's policy and endogenously determines the model, Central Banks may fall in a learning trap. An increase in financial volatility provides an escape to such trap that replicates patterns in the data.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 34 (2010)
Issue (Month): 10 (October)
Pages: 1923-1950

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:10:p:1923-1950
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