Adaptive Learning with a Unit Root: An Application to the Current Account

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Title: Adaptive Learning with a Unit Root: An Application to the Current Account
Author: Davies, Ronald B.; Shea, Paul, 1977-
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.
URI: http://hdl.handle.net/1794/3882
Date: 2006-07-31


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