Adaptive Learning with a Unit Root: An Application to the Current Account
This paper develops a simple two-country, two-good model of international trade and borrowing that suppresses all previous sources of current account dynamics. Under rational expectations, international debt follows a random walk. Under adaptive learning however, international debt behaves like either a stationary or an explosive process. Whether debt converges or diverges depends on the specific learning algorithm that agents employ. When debt diverges, a financial crisis eventually occurs to ensure that the modelÂ’s transversality condition holds. Such a financial crisis causes an abrupt decrease in the debtor countryÂ’s consumption and utility.
|Date of creation:||10 Apr 2003|
|Date of revision:||10 Jun 2003|
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