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

  • Matthes, Christian
  • Rondina, Francesca

This paper investigates the role of learning by both private agents and the central bank (two-sided learning) in a New Keynesian framework populated by private agents and a central bank that have asymmetric imperfect knowledge about the true data generating process. We assume that all agents employ the data they observe (which can be different for different sets of agents) to form beliefs about the aspects of the true model of the economy that they do not know, use these beliefs to decide on actions, and revise beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of the model and policy recommendations coming out of our model, in particular concerning central bank communication. Two-sided learning can generate large increases in volatility and persistence, and can alter the behavior of the variables in the model in a significant way. We also show that our model does not converge to a symmetric rational expectations equilibrium and highlight one source that disables the convergence results of Marcet & Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank’ model is substantially misspecified.

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Paper provided by CEPREMAP in its series Dynare Working Papers with number 19.

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Length: 30 pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:cpm:dynare:019
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  1. George W. Evans & Seppo Honkapohja, 2006. "Monetary Policy, Expectations and Commitment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 108(1), pages 15-38, 03.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
  3. Eusepi, Stefano & Preston, Bruce, 2007. "Central bank communication and expectations stabilization," Proceedings, Federal Reserve Bank of San Francisco, issue March, pages 1-43.
  4. James Bullard & Stefano Eusepi, 2003. "Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?," Computing in Economics and Finance 2003 129, Society for Computational Economics.
  5. George W. Evans & Seppo Honkapohja, 2002. "Adaptive Learning and Monetary Policy Design," University of Oregon Economics Department Working Papers 2002-18, University of Oregon Economics Department, revised 04 Mar 2004.
  6. Athanasios Orphanides & John C. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Working Paper Series 2003-24, Federal Reserve Bank of San Francisco.
  7. Barnett, Alina & Ellison, Martin, 2012. "Learning by disinflating," Research Discussion Papers 10/2012, Bank of Finland.
  8. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  9. Honkapohja, Seppo & Mitra, Kaushik, 2005. "Performance of monetary policy with internal central bank forecasting," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 627-658, April.
  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, 1998. "Economic Dynamics with Learning: New Stability Results," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 23-44.
  12. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Adaptive learning in practice," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2659-2697, August.
  13. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  14. William A. Brock & Steven N. Durlauf & James M. Nason & Giacomo Rondina, 2007. "Simple versus optimal rules as guides to policy," FRB Atlanta Working Paper 2007-07, Federal Reserve Bank of Atlanta.
  15. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
  16. 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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