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Adaptive learning and multiple equilibria in a natural rate monetary model with unemployment persistence

  • Rantala, Anssi

    (Bank of Finland Research)

Registered author(s):

    This paper demonstrates that the adaptive learning approach to modelling private sector expectations can be used as an equilibrium selection mechanism in a natural-rate monetary model with unemployment persistence. In particular, it is shown that only one of the two rational expectations equilibria is stable under least-squares learning, and that it is always the low-inflation equilibrium with intuitive comparative statics properties that is the learnable equilibrium. Hence, this paper provides a basic theoretical justification for focusing on the low-inflation equilibrium. Earlier contributions, in which the high-inflation equilibrium was ignored, mainly because of its unpleasant characteristics, are not theoretically satisfactory.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0330.pdf
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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 30/2003.

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    Length: 30 pages
    Date of creation: 12 Nov 2003
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2003_030
    Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/

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    1. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
    2. Lockwood, Ben & Philippopoulos, Apostolis, 1994. "Insider Power, Unemployment Dynamics and Multiple Inflation Equilibria," Economica, London School of Economics and Political Science, vol. 61(241), pages 59-77, February.
    3. Lockwood, B. & Miller, M. & Zhang, L., 1994. "Designing Monetary Policy when Unemployment Persists," Discussion Papers 9408, Exeter University, Department of Economics.
    4. Athanasios Orphanides & John C. Williams, 2002. "Imperfect knowledge, inflation expectations, and monetary policy," Working Paper Series 2002-04, Federal Reserve Bank of San Francisco.
    5. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
    6. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," Working papers 427, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Jensen, Henrik, 1999. "Monetary policy cooperation and multiple equilibria," Journal of Economic Dynamics and Control, Elsevier, vol. 23(8), pages 1133-1153, August.
    8. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173, March.
    9. Henrik Jensen & Roel M. W. J. Beetsma, 1999. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts: Comment," American Economic Review, American Economic Association, vol. 89(1), pages 342-347, March.
    10. Svensson, Lars E O, 1999. "Price-Level Targeting versus Inflation Targeting: A Free Lunch?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 277-95, August.
    11. Cho, In-Koo & Williams, Noah & Sargent, Thomas J, 2002. "Escaping Nash Inflation," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 1-40, January.
    12. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    13. William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
    14. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers 3/2002, Bank of Finland.
    15. Lindbeck, Assar & Snower, Dennis J, 1986. "Wage Setting, Unemployment, and Insider-Outsider Relations," American Economic Review, American Economic Association, vol. 76(2), pages 235-39, May.
    16. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    17. Lockwood, Ben, 1997. "State-Contingent Inflation Contracts and Unemployment Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 286-99, August.
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