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

  • Rantala, Anssi

    (Bank of Finland Research)

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    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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    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
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    1. Roel M.W.J. Beetsma & Henrik Jensen, . "Optimal Inflation Targets, “Conservative” Central Banks, and Linear Inflation Contracts: Comment," EPRU Working Paper Series 98-11, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    2. Honkapohja, Seppo & Evans, George W., 2000. "Expectations and the stability problem for optimal monetary policies," Discussion Paper Series 1: Economic Studies 2000,10, Deutsche Bundesbank, Research Centre.
    3. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series 0127, European Central Bank.
    4. 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.
    5. Cho, In-Koo & Sargent, Thomas J., 2000. "Escaping Nash inflation," Working Paper Series 0023, European Central Bank.
    6. 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.
    7. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173.
    8. William Poole, 2002. "Flation," Speech 49, Federal Reserve Bank of St. Louis.
      • William Poole & Robert H. Rasche, 2002. "Flation," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 1-6.
    9. Lockwood, B. & Miller, M. & Zhang, L., 1994. "Designing Monetary Policy when Unemployment Persists," Discussion Papers 9408, Exeter University, Department of Economics.
    10. Athanasios Orphanides & John Williams, 2004. "Imperfect Knowledge, Inflation Expectations, and Monetary Policy," NBER Chapters, in: The Inflation-Targeting Debate, pages 201-246 National Bureau of Economic Research, Inc.
    11. George W. Evans & Seppo Honkapohja, 2003. "Adaptive learning and monetary policy design," Proceedings, Federal Reserve Bank of Cleveland, pages 1045-1084.
    12. Jensen, Henrik, 1999. "Monetary policy cooperation and multiple equilibria," Journal of Economic Dynamics and Control, Elsevier, vol. 23(8), pages 1133-1153, August.
    13. Svensson, Lars E O, 1996. "Price-level Targeting versus Inflation Targeting: A Free Lunch?," CEPR Discussion Papers 1510, C.E.P.R. Discussion Papers.
    14. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," Working papers 427, Massachusetts Institute of Technology (MIT), Department of Economics.
    15. 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.
    16. 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.
    17. 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.
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