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Two-sided Learning in New Keynesian Models: Dynamics, (Lack of) Convergence and the Value of Information

  • Christian Matthes
  • Francesca Rondina

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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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 661.

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Date of creation: Sep 2012
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Handle: RePEc:bge:wpaper:661
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  1. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  3. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  4. William A. Brock & Steven N. Durlauf & James M. Nason & Giacomo Rondina, 2007. "Simple versus optimal rules as guides to policy," Working Paper 2007-07, Federal Reserve Bank of Atlanta.
  5. Evans, George W. & Honkapohja, Seppo, 2002. "Monetary Policy, Expectations and Commitment," CEPR Discussion Papers 3434, C.E.P.R. Discussion Papers.
  6. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
  7. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  8. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
  9. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series 0127, European Central Bank.
  10. A. Orphanides & J. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  11. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," Discussion Papers 0708-10, Columbia University, Department of Economics.
  12. 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.
  13. Milani, Fabio, 2008. "Learning, monetary policy rules, and macroeconomic stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3148-3165, October.
  14. Barnett, Alina & Ellison, Martin, 2012. "Learning by disinflating," Research Discussion Papers 10/2012, Bank of Finland.
  15. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
  16. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
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