Two-Sided Learning in a Natural Rate Model
, under review at Journal of Macroeconomics
Abstract:
Cho, Williams and Sargent (2002) consider a natural rate model in which the central bank has imperfect control over inflation and is uncertain of the actual laws of motion of the economy. They show that if the central bank uses a misspecified approximating model to determine inflation there can be endogenous cycling (escape dynamics) between the time-consistent Nash equilibrium outcome and the optimal Ramsey outcome of Kydland and Prescott (1977). They obtain these escape dynamics assuming the central bank and the private sector have the same information and beliefs about the economy. In this paper we assume these two actors have different beliefs about the structure of the economy. The central bank and the private sector learn the economy with their own models separately. If the private sector learns the economy with a fully specified model instead of having rational expectations, escapes disappear and the economy converges to the Nash outcome. With a reverse robustness check we .find that escapes can reappear if the private sector uses a misspecified model and the central bank uses a fully specified model. Thus escapes can arise in a model where the central bank is better informed than the private sector. Moreover under certain conditions the difference in beliefs in a two-sided learning model allows the central bank to exploit the expectations of the private sector to achieve a lower than Nash equilibrium outcome level of inflation.
Central Bank's Influence
on Public Expectations
Abstract:
Using a New Keynesian model, we show that a central bank with an extraneous instrument, "cheap talk" announcements, can influence the private sector to achieve better outcomes than could be obtained by manipulating the nominal interest rate alone. Announcements are effective only if the central bank has full knowledge of how private sector expectations are formed, in which case the central bank can achieve lower inflation and higher output. Otherwise the private sector learns to discount announcements, and we observe convergence to the Nash equilibrium levels of inflation and output.
Learning and Dynamic Inefficiency with Prof. John Duffy
Abstract:
We examine the question of the stability of equilibria under adaptive learning in Diamond’s (1965) overlapping-generations model with productive capital and money. In particular, we are interested in whether dynamically inefficient equilibria, which are possible in this model, are stable under adaptive learning. This model has one more asset, capital, than the model considered by Lucas (1986), Marcet and Sargent (1989) and others. Lucas (1986) showed that if agents used a simple adaptive learning rule, they would converge upon the unique monetary equilibrium of a two-period pure exchange OLG model with money as the single outside asset. We show that adaptive learning does not eliminate the multiplicity of stationary equilibria in the Diamond overlapping generations model with money and productive capital; both dynamically efficient and inefficient equilibria are found to be stable under adaptive learning.
On Escape Dynamics in Oligopoly Models, Working Paper
It is known that in adaptive learning models, misspecification of the approximating learning model may lead to endogenous fluctuations of the state variables. Williams (2002) builds methods for analyzing these endogenous fluctuations. In this paper we show that the endogenous fluctuations critically depend on the model and the distribution of the noises chosen. We show that when we match the Nash equilibrium and the Cartel equilibrium of the Bertrand competition and the Cournot competition models and use normal shocks, there are endogenous fluctuations of the state variables in the Bertrand competition model where there is convergence of the state variables to the equilibrium values in the Cournot competition model. But when we use binomial shocks instead of normal shocks, we observe the results reverse and we observe convergence of the state variables to the equilibrium values in the Bertrand competition model and endogenous fluctuations of the state variables in the Cournot competition model.
A New Commitment, Very first draft of my latest working paper
In this paper, I am investigating whether the central bank can influence the private sector if it commits to a particular inflation rate and announces this commitment to the private sector. Moreover, the central bank assumes the private sector will believe it is committed to this target rate in deriving its optimal policy function. My initial results show the central bank is able to achieve credibility in time as the private sector’s expectations converge to the central bank’s target rate.