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Two-sided learning in New Keynesian models: Dynamics, (lack of) convergence and the value of information

  • Christian Matthes
  • Francesca Rondina

This paper investigates the role of learning by private agents and the central bank (two-sided learning) in a New Keynesian framework in which both sides of the economy have asymmetric and imperfect knowledge about the true data generating process. We assume that all agents employ the data that they observe (which may be distinct for different sets of agents) to form beliefs about unknown aspects of the true model of the economy, use their beliefs to decide on actions, and revise these beliefs through a statistical learning algorithm as new information becomes available. We study the short-run dynamics of our model and derive its policy recommendations, particularly with respect to central bank communications. We demonstrate that two-sided learning can generate substantial increases in volatility and persistence, and alter the behavior of the variables in the model in a significant way. Our simulations do not converge to a symmetric rational expectations equilibrium and we highlight one source that invalidates the convergence results of Marcet and Sargent (1989). Finally, we identify a novel aspect of central bank communication in models of learning: communication can be harmful if the central bank's model is substantially mis-specified.

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File URL: http://www.econ.upf.edu/docs/papers/downloads/1338.pdf
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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1338.

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Date of creation: Sep 2012
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Handle: RePEc:upf:upfgen:1338
Contact details of provider: Web page: http://www.econ.upf.edu/

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  1. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  2. Kaushik Mitra & Seppo Honkapohja, 2004. "Performance of Monetary Policy with Internal Central Bank Forecasting," Royal Holloway, University of London: Discussion Papers in Economics 04/18, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  3. George W. Evans & Seppo Honkapohja, 2006. "Monetary Policy, Expectations and Commitment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 108(1), pages 15-38, 03.
  4. A. Orphanides & J. Williams, 2003. "The decline of activist stabilization policy: natural rate misperceptions, learning, and expectations," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  5. Alina Barnett & Martin Ellison, 2013. "Learning by Disinflating," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 731-746, 06.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
  7. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  8. William A. Brock & Steven N. Durlauf & James M. Nason & Giacomo Rondina, 2007. "Simple versus optimal rules as guides to policy," Working Paper 2007-07, Federal Reserve Bank of Atlanta.
  9. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers 29/2002, Bank of Finland.
  10. Fabio Milani, 2005. "Learning, Monetary Policy Rules, and Macroeconomic Stability," Macroeconomics 0508019, EconWPA.
  11. James Bullard & Stefano Eusepi, 2003. "Did the Great Inflation occur despite policymaker commitment to a Taylor rule?," Working Paper 2003-20, Federal Reserve Bank of Atlanta.
  12. Chryssi Giannitsarou & Eva Carceles-Poveda, 2004. "Adaptive Learning in Practice," Computing in Economics and Finance 2004 271, Society for Computational Economics.
  13. George W. Evans & Seppo Honkapohja, . "Economic Dynamics with Learning: New Stability Results," Computing in Economics and Finance 1997 51, Society for Computational Economics.
  14. Timothy Cogley & Christian Matthes & Argia M. Sbordone, 2011. "Optimal disinflation under learning," Staff Reports 524, Federal Reserve Bank of New York.
  15. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  16. Chryssi Giannitsarou, 2003. "Heterogeneous Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 885-906, October.
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