Research Discussion Papers, Bank of Finland
No 8/2011:
Learning as a rational foundation for macroeconomics and finance
George W Evans and Seppo Honkapohja ()
Abstract: Expectations play a central role in modern macroeconomics.
The econometric learning approach, in line with the cognitive consistency
principle, models agents as forming expectations by estimating and updating
subjective forecasting models in real time. This approach provides a
stability test for RE equilibria and a selection criterion in models with
multiple equilibria. Further features of learning – such as discounting of
older data, use of misspecified models or heterogeneous choice by agents
between competing models – generate novel learning dynamics. Empirical
applications are reviewed and the roles of the planning horizon and
structural knowledge are discussed. We develop several applications of
learning with relevance to macroeconomic policy: the scope of Ricardian
equivalence, appropriate specification of interest-rate rules,
implementation of price-level targeting to achieve learning stability of
the optimal RE equilibrium and whether, under learning, price-level
targeting can rule out the deflation trap at the zero lower bound.
Keywords: cognitive consistency; E-stability; least-squares; persistent learning dynamics; business cycles; monetary policy; asset prices; (follow links to similar papers)
JEL-Codes: C62; D83; D84; E32; (follow links to similar papers)
63 pages, March 24, 2011
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