Working Paper: CEPR ID: DP2882
Authors: Martin Lettau; Timothy Van Zandt
Abstract: Dynamic models in which agents' behaviour depends on expectations of future prices or other endogenous variables can have steady states that are stationary equilibria for a wide variety of expectations rules, including rational expectations. When there are multiple steady states, stability is a criterion for selecting predictions of long-run outcomes among them. The purpose of this Paper is to study how sensitive stability is to certain details of the expectations rules, in a simple OLG model with constant government debt that is financed through seigniorage. We compare simple recursive learning rules, learning rules with vanishing gain, and OLS learning, and also relate these to expectational stability. One finding is that two adaptive expectation rules that differ only in whether they use current information can have opposite stability properties.
Keywords: adaptive expectations; inflation; stability
JEL Codes: D84; E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expectations rules employed by agents (D84) | stability of low inflation steady state (E31) |
| expectations rules employed by agents (D84) | stability of high inflation steady state (E31) |
| current information used by agents (L85) | stability of high inflation steady state (E31) |
| lagged information used by agents (D83) | instability of high inflation steady state (E31) |
| current information used by agents (L85) | stability of low inflation steady state (E31) |
| timing of information (G14) | stability outcomes (C62) |