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Robust Learning Stability with Operational Monetary Policy Rules

We consider robust stability under learning of alternative interest-rate rules. By “robust stability” we mean stability of the rational expectations equilibrium, under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that many interest-rate rules are not robust, in this sense, when operational forms of policy rules are employed. Rules are considered operational if they do not depend on contemporaneous values of endogenous aggregate variables. 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 of the rules that aim to achieve optimal policy, 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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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 504.

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Date of creation: Nov 2008
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Handle: RePEc:chb:bcchwp:504
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  1. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076 Central Bank of Chile.
  2. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  3. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, vol. 32(104-105), pages 383-393, June.
  4. Fabio Milani, 2005. "Adaptive Learning and Inflation Persistence," Macroeconomics 0506013, EconWPA.
  5. Evans George W. & Guesnerie Roger, 1993. "Rationalizability, Strong Rationality, and Expectational Stability," Games and Economic Behavior, Elsevier, vol. 5(4), pages 632-646, October.
  6. Fabio Milani, 2007. "Learning and Time-Varying Macroeconomic Volatility," Working Papers 070802, University of California-Irvine, Department of Economics.
  7. Evans, George W. & Honkapohja, Seppo, 2002. "Monetary policy, expectations and commitment," Working Paper Series 0124, European Central Bank.
  8. George W. Evans & Seppo Honkapohja, 2004. "Adaptive learning and monetary policy design," Macroeconomics 0405008, EconWPA.
  9. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  10. Sergey Slobodyan & Anna Bogomolova & Dmitri Kolyuzhnov, 2006. "Stochastic Gradient versus Recursive Least Squares Learning," Computing in Economics and Finance 2006 446, Society for Computational Economics.
  11. Evans, George W & Honkapohja, Seppo, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Wiley Blackwell, vol. 65(1), pages 23-44, January.
  12. Orphanides, Athanasios & Williams, John C., 2003. "Imperfect knowledge, inflation expectations, and monetary policy," CFS Working Paper Series 2003/40, Center for Financial Studies (CFS).
  13. George W. Evans & Seppo Honkapohja & Noah Williams, 2005. "Generalized Stochastic Gradient Learning," NBER Technical Working Papers 0317, National Bureau of Economic Research, Inc.
  14. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  15. McCallum, Bennett T & Nelson, Edward, 2001. "Timeless Perspective Vs Discretionary Monetary Policy in Forward-Looking Models," CEPR Discussion Papers 2752, C.E.P.R. Discussion Papers.
  16. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
  17. 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.
  18. George W. Evans & Seppo Honkapohja, 2008. "Learning and Macroeconomics," University of Oregon Economics Department Working Papers 2008-3, University of Oregon Economics Department.
  19. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  20. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  21. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Macroeconomics 0510022, EconWPA.
  22. 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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