IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Adaptive Learning and Monetary Policy: Lessons from Japan

  • Yu-chin Chen

    (University of Washington)

  • Pisut Kulthanavit

    (University of Washington)

Motivated by Japan's economic experiences and policy debates over the past two decades, this paper uses a dynamic general equilibrium open economy model to examine the volatility and welfare impact of alternative monetary policies. To capture the dynamic effects of likely structural breaks in the Japanese economy, we model agents’ expectation formation process with an adaptive learning framework, and compare four Taylor-styled policy rules that reflect concerns commonly raised in Japan's actual monetary policy debate. We first show that imperfect knowledge and the associated learning process induce higher volatility in the economy, while still retaining some of the policy conclusions from rational-expectations setups. In particular, explicit exchange rate stabilization is unwarranted; moreover, under volatile foreign disturbances, policymakers should consider targeting domestic price inflation rather than consumer price inflation. However, contrary to results based on rational expectations, we show that even though highly inflation-sensitive rules do raise output volatility, they may nevertheless improve overall welfare in an adaptive learning setting by smoothing inflation fluctuations. Our findings suggest that previous policy conclusions that are based on partial equilibrium analyses, or that ignore likely deviations from rational expectations, may not be robust.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://faculty.washington.edu/yuchin/Papers/Chen-Kulthanavit.pdf
Download Restriction: no

Paper provided by University of Washington, Department of Economics in its series Working Papers with number UWEC-2008-12-P.

as
in new window

Length:
Date of creation: Jun 2008
Date of revision: Oct 2008
Publication status: Published in Pacific Economic Review, Volume 2008, Volume 13 Issue 4, Pages 405 - 430
Handle: RePEc:udb:wpaper:uwec-2008-12-p
Contact details of provider: Postal:
Box 353330, Seattle, WA 98193-3330

Web page: http://www.econ.washington.edu/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Takatoshi Ito & Frederic S. Mishkin, 2006. "Two Decades of Japanese Monetary Policy and the Deflation Problem," NBER Chapters, in: Monetary Policy with Very Low Inflation in the Pacific Rim, NBER-EASE, Volume 15, pages 131-202 National Bureau of Economic Research, Inc.
  2. Branch, William A. & Evans, George W., 2006. "A simple recursive forecasting model," Economics Letters, Elsevier, vol. 91(2), pages 158-166, May.
  3. Kosuke Aoki & Kalin Nikolov, 2004. "Rule-based monetary policy under central bank learning," Bank of England working papers 235, Bank of England.
  4. Orphanides, Athanasios & Williams, John C., 2003. "Imperfect knowledge, inflation expectations, and monetary policy," CFS Working Paper Series 2003/40, Center for Financial Studies (CFS).
  5. Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
  6. Athanasios Orphanides & John C. Williams, 2006. "Inflation Targeting Under Imperfect Knowledge," Working Papers Central Bank of Chile 398, Central Bank of Chile.
  7. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  8. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  9. John C Williams & Athanasios Orphanides, 2005. "Robust Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2005 400, Society for Computational Economics.
  10. Laurence Ball, 1998. "Policy Rules for Open Economies," NBER Working Papers 6760, National Bureau of Economic Research, Inc.
  11. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
  12. McCallum, Bennett T & Nelson, Edward, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," CEPR Discussion Papers 2756, C.E.P.R. Discussion Papers.
  13. Bullard, James & Schaling, Eric, 2006. "Monetary policy, determinacy, and learnability in the open economy," Working Paper Series 0611, European Central Bank.
  14. Bennett T. McCallum & Edward Nelson, . "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," GSIA Working Papers 1998-22, Carnegie Mellon University, Tepper School of Business.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  16. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  17. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
  18. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  19. Evans, George W. & Honkapohja, Seppo, 2002. "Monetary Policy, Expectations and Commitment," CEPR Discussion Papers 3434, C.E.P.R. Discussion Papers.
  20. Bennett T. McCallum & Edward Nelson, 2000. "Timeless Perspectives vs. Discretionary Monetary Policy In Forward-Looking Models," NBER Working Papers 7915, National Bureau of Economic Research, Inc.
  21. 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.
  22. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  23. Kenneth N. Kuttner & Adam S. Posen, 2001. "The Great Recession: Lessons for Macroeconomic Policy from Japan," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(2), pages 93-186.
  24. Nunes, Ricardo, 2009. "Learning The Inflation Target," Macroeconomic Dynamics, Cambridge University Press, vol. 13(02), pages 167-188, April.
  25. Lars E.O. Svensson, 2003. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 145-166, Fall.
  26. Evans, George W. & Honkapohja, Seppo, 2003. "Adaptive Learning and Monetary Policy Design," CEPR Discussion Papers 3962, C.E.P.R. Discussion Papers.
  27. Tommaso Monacelli, 1999. "Into the Mussa Puzzle: Monetary Policy Regimes and the Real Exchange Rate in a Small Open Economy," Boston College Working Papers in Economics 437, Boston College Department of Economics, revised 15 Sep 2000.
  28. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
  29. Vitor Gaspar & Frank Smets & David Vestin, 2006. "Adaptive Learning, Persistence, and Optimal Monetary Policy," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 376-385, 04-05.
  30. James B. Bullard & John Duffy, 2004. "Learning and structural change in macroeconomic data," Working Papers 2004-016, Federal Reserve Bank of St. Louis.
  31. Ronald I. McKinnon & Kenichi Ohno, 1997. "Dollar and Yen: Resolving Economic Conflict between the United States and Japan," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262133350, December.
  32. Schmidt-Hebbel, Klaus & Tapia, Matias, 2002. "Inflation targeting in Chile," The North American Journal of Economics and Finance, Elsevier, vol. 13(2), pages 125-146, August.
  33. McCallum, Bennett T., 1998. "Solutions to linear rational expectations models: a compact exposition," Economics Letters, Elsevier, vol. 61(2), pages 143-147, November.
  34. James B. Bullard & Kaushik Mitra, 2003. "Determinacy, learnability, and monetary policy inertia," Working Papers 2000-030, Federal Reserve Bank of St. Louis.
  35. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  36. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 743-764.
  37. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  38. Yu-chin Chen & Pisut Kulthanavit, 2008. "Monetary Policy Design under Imperfect Knowledge: An Open Economy Analysis," Working Papers UWEC-2008-14, University of Washington, Department of Economics.
  39. Peter M. Summers, 2005. "What caused the Great Moderation? : some cross-country evidence," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-32.
  40. Bennett T. McCallum & Edward Nelson, 2004. "Targeting vs. instrument rules for monetary policy," Working Papers 2004-011, Federal Reserve Bank of St. Louis.
  41. Kuttner, Kenneth N. & Posen, Adam S., 2004. "The difficulty of discerning what's too tight: Taylor rules and Japanese monetary policy," The North American Journal of Economics and Finance, Elsevier, vol. 15(1), pages 53-74, March.
  42. Waters, George A., 2009. "Learning, Commitment, And Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 13(04), pages 421-449, September.
  43. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  44. de Andrade, Joaquim Pinto & Divino, Jose Angelo, 2005. "Monetary policy of the Bank of Japan--inflation target versus exchange rate target," Japan and the World Economy, Elsevier, vol. 17(2), pages 189-208, April.
  45. Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 225-245.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:udb:wpaper:uwec-2008-12-p. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michael Goldblatt)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.