Economics Working Papers
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This collection contains papers in the University of Oregon Economics Department Working Papers series. Papers in this series are also available on the department's web site at: http://econpapers.repec.org/paper/oreuoecwp/
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Browsing Economics Working Papers by Subject "Adaptive learning"
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Item Open Access Adaptive Learning and Monetary Policy Design(University of Oregon, Dept. of Economics, 2002-11-08) Evans, George W., 1949-; Honkapohja, Seppo, 1951-We review the recent work on interest rate setting, which emphasizes the desirability of designing policy to ensure stability under private agent learning. Appropriately designed expectations based rules can yield optimal rational expectations equilibria that are both determinate and stable under learning. Some simple instrument rules and approximate targeting rules also have these desirable properties. We take up various complications in implementing optimal policy, including the observability of key variables and the required knowledge of structural parameters. An additional issue that we take up concerns the implications of expectation shocks not arising from transitional learning effects.Item Open Access Adaptive Learning with a Unit Root: An Application to the Current Account(University of Oregon, Dept of Economics, 2006-07-31) Davies, Ronald B.; Shea, Paul, 1977-This paper develops a simple two-country, two-good model of international trade and borrowing that suppresses all previous sources of current account dynamics. Under rational expectations, international debt follows a random walk. Under adaptive learning however, international debt behaves like either a stationary or an explosive process. Whether debt converges or diverges depends on the model’s exact specification and the specific learning algorithm that agents employ. When debt diverges, a financial crisis eventually occurs to ensure that the model’s transversality condition holds. Such a financial crisis causes an abrupt decrease in the debtor country’s consumption and utility.Item Open Access Adaptive Learning, Endogenous Inattention, and Changes in Monetary Policy(University of Oregon, Dept of Economics, 2006-06-22) Branch, William A.; Evans, George W., 1949-; Carlson, John; McGough, BruceThis paper develops an adaptive learning formulation of an extension to the Ball, Mankiw and Reis (2005) sticky information model that incorporates endogenous inattention. We show that, following an exogenous increase in the policymaker’s preferences for price vs. output stability, the learning process can converge to a new equilibrium in which both output and price volatility are lower.Item Open Access Asset Return Dynamics and Learning(University of Oregon, Dept of Economics, 2006-11-13) Branch, William A.; Evans, George W., 1949-This paper advocates a theory of expectation formation that incorporates many of the central motivations of behavioral finance theory while retaining much of the discipline of the rational expectations approach. We provide a framework in which agents, in an asset pricing model, underparameterize their forecasting model in a spirit similar to Hong, Stein, and Yu (2005) and Barberis, Shleifer, and Vishny (1998), except that the parameters of the forecasting model, and the choice of predictor, are determined jointly in equilibrium. We show that multiple equilibria can exist even if agents choose only models that maximize (risk-adjusted) expected profits. A real-time learning formulation yields endogenous switching between equilibria. We demonstrate that a realtime learning version of the model, calibrated to U.S. stock data, is capable of reproducing many of the salient empirical regularities in excess return dynamics such as under/overreaction, persistence, and volatility clustering.Item Open Access Comment on "Imperfect Knowledge, Inflation Expectations and Monetary Policy" by Athanasios Orphanides and John C. Williams(University of Oregon, Dept. of Economics, 2003-03-31) Evans, George W., 1949-Summarizes the Orphanides-Williams argument, locates the paper within the rapidly growing literature on learning and monetary policy, and offers specific comments on natural extensions or alternative approaches.Item Open Access Expectations, Deflation Traps and Macroeconomic Policy(University of Oregon, Dept of Economics, 2009-07-06) Evans, George W., 1949-; Honkapohja, Seppo, 1951-We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.Item Open Access Generalized Stochastic Gradient Learning(University of Oregon, Dept of Economics, 2005-09-19) Evans, George W., 1949-; Honkapohja, Seppo, 1951-We study the properties of generalized stochastic gradient (GSG) learning in forwardlooking models. We examine how the conditions for stability of standard stochastic gradient (SG) learning both differ from and are related to E-stability, which governs stability under least squares learning. SG algorithms are sensitive to units of measurement and we show that there is a transformation of variables for which E-stability governs SG stability. GSG algorithms with constant gain have a deeper justification in terms of parameter drift, robustness and risk sensitivity.Item Open Access Learning about Risk and Return: A Simple Model of Bubbles and Crashes(University of Oregon, Dept of Economics, 2008-01-31) Branch, William A.; Evans, George W., 1949-This paper demonstrates that an asset pricing model with least-squares learning can lead to bubbles and crashes as endogenous responses to the fundamentals driving asset prices. When agents are risk-averse they generate forecasts of the conditional variance of a stock’s return. Recursive updating of the conditional variance and expected return implies two mechanisms through which learning impacts stock prices: occasional shocks may lead agents to lower their risk estimate and increase their expected return, thereby triggering a bubble; along a bubble path recursive estimates of risk will increase and crash the bubble.Item Open Access Liquidity Traps, Learning and Stagnation(University of Oregon, Dept of Economics, 2007-06-05) Evans, George W., 1949-; Guse, Eran A. (Eran Alan), 1975-; Honkapohja, Seppo, 1951-We examine global economic dynamics under learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. Under normal monetary and fiscal policy, the intended steady state is locally but not globally stable. Large pessimistic shocks to expectations can lead to deflationary spirals with falling prices and falling output. To avoid this outcome we recommend augmenting normal policies with aggressive monetary and fiscal policy that guarantee a lower bound on inflation. In contrast, policies geared toward ensuring an output lower bound are insufficient for avoiding deflationary spirals.Item Open Access Model Uncertainty and Endogenous Volatility(University of Oregon, Dept of Economics, 2005-10-18) Branch, William A.; Evans, George W., 1949-This paper identifies two channels through which the economy can generate endogenous inflation and output volatility, an empirical regularity, by introducing model uncertainty into a Lucas-type monetary model. The equilibrium path of inflation depends on agents' expectations and a vector of exogenous random variables. Following Branch and Evans (2004) agents are assumed to underparameterize their forecasting models. A Misspecification Equilibrium arises when beliefs are optimal given the misspecification and predictor proportions based on relative forecast performance. We show that there may exist multiple Misspecification Equilibria, a subset of which are stable under least squares learning and dynamic predictor selection. The dual channels of least squares parameter updating and dynamic predictor selection combine to generate regime switching and endogenous volatility.Item Open Access Monetary Policy and Heterogeneous Expectations(University of Oregon, Dept of Economics, 2010-04-30) Branch, William A.; Evans, George W., 1949-This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expec- tations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilibrium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have important implications for business cycle dynamics and for the design of monetary policy.Item Open Access Monetary Policy, Endogenous Inattention, and the Volatility Trade-off(University of Oregon, Dept of Economics, 2004-12-07) Branch, William A.; Carlson, John; Evans, George W., 1949-; McGough, BruceThis paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "Great Moderation" that began in the 1980's.Item Open Access Monetary Policy, Expectations and Commitment(University of Oregon, Dept of Economics, 2005-04-06) Evans, George W., 1949-; Honkapohja, Seppo, 1951-This is a revised and shortened version of Working Paper 2002-11. Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules have been proposed to implement or approximate commitment policy. We assess these rules in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private expectations performs particularly well on both counts.Item Open Access Monetary policy, expectations and commitment(University of Oregon, Dept. of Economics, 2002-05-22) Evans, George W., 1949-; Honkapohja, Seppo, 1951-Commitment in monetary policy leads to equilibria that are superior to those from optimal discretionary policies. A number of interest rate reaction functions and instrument rules have been proposed to implement or approxmiate commitment policy. We assess these optimal reaction functions and instrument rules in terms of whether they lead to an RE equilibrium that is both locally determinate and stable under adaptive learning by private agents. A reaction function that appropriately depends explicitly on private expectations performs well on both counts.