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Two-sided Learning and Optimal Monetary Policy in an Open Economy Model

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  • Timothy Kam

    (UWA Business School, The University of Western Australia)

Abstract

In this paper, we consider a dynamic New Keynesian model of the small open economy in the light of bounded rationality. This entails private agents and the central bank updating their beliefs about the laws of motion of inflation, the output gap and real exchange rate, when forming their optimal decisions. It is shown that when all players learn using recursive least-squares or stochastic-gradient adaptive algorithms, the optimal policy steers the economy towards a rational expectations equilibrium (REE) with probability one in some cases. This is also the case when only private agents are learning. However there also exists structural parameter values in the true model such that learning converges with probability zero to REE.

Suggested Citation

  • Timothy Kam, 2004. "Two-sided Learning and Optimal Monetary Policy in an Open Economy Model," Economics Discussion / Working Papers 04-07, The University of Western Australia, Department of Economics.
  • Handle: RePEc:uwa:wpaper:04-07
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    References listed on IDEAS

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    Cited by:

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    2. Fujisaki, Seiya, 2012. "Interest Rate Control Rules and Macroeconomic Stability in a Heterogeneous Two-Country Model," MPRA Paper 37017, University Library of Munich, Germany.

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    More about this item

    Keywords

    Optimal monetary policy; Small open economy; Learning; Stochastic approximation;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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