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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. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers 3/2002, Bank of Finland.
  2. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2006. "Adaptive Learning in Practice," CEPR Discussion Papers 5627, C.E.P.R. Discussion Papers.
  3. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  4. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," Discussion Papers 0708-10, Columbia University, Department of Economics.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  6. 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.
  7. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
  8. 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.
  9. Evans, George W. & Honkapohja, Seppo, 2002. "Monetary Policy, Expectations and Commitment," CEPR Discussion Papers 3434, C.E.P.R. Discussion Papers.
  10. Alina Barnett & Martin Ellison, 2013. "Learning by Disinflating," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 731-746, 06.
  11. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  12. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
  13. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  14. Brock, William A. & Durlauf, Steven N. & Nason, James M. & Rondina, Giacomo, 2007. "Simple versus optimal rules as guides to policy," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1372-1396, July.
  15. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
  16. Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.
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