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The limits to robust monetary policy in a small open economy with learning agents

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  • Marine Charlotte André
  • Meixing Dai

Abstract

We study the impact of adaptive learning for the design of a robust monetary policy using a small open-economy New Keynesian model. We find that slightly departing from rational expectations substantially changes the way the central bank deals with model misspecification. Learning induces an intertemporal trade-off for the central bank, i.e., stabilizing inflation (output gap) today or stabilizing it tomorrow. The central bank should optimally anchoring private agents expectations in the short term in exchange of easier future intratemporal trade-offs. Compared to the rational expectations equilibrium, the possibility to conduct robust monetary policy is limited in a small open economy under learning for any exchange rate pass-through level and any degree of trade openness. The misspecification that can be introduced into all equations of the model is lower in a small open economy, and approaches zero at high speed as the learning gain rises.

Suggested Citation

  • Marine Charlotte André & Meixing Dai, 2020. "The limits to robust monetary policy in a small open economy with learning agents," Working Papers 2020-12, Banco de México.
  • Handle: RePEc:bdm:wpaper:2020-12
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The limits to robust monetary policy in a small open economy with learning agents
      by Christian Zimmermann in NEP-DGE blog on 2020-10-26 23:37:43

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    More about this item

    Keywords

    Robust control; model uncertainty; adaptive learning; small open economy;
    All these keywords.

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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