Adaptive Learning with a Unit Root: An Application to the Current Account
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Date
2006-07-31
Authors
Davies, Ronald B.
Shea, Paul, 1977-
Journal Title
Journal ISSN
Volume Title
Publisher
University of Oregon, Dept of Economics
Abstract
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.
Description
39 p.
Keywords
Current account, International debt movements, Expectations, Adaptive learning