Working Paper: CEPR ID: DP6641
Authors: George W. Evans; Seppo Honkapohja
Abstract: We consider "robust stability" of a rational expectations equilibrium, which we define as stability under discounted (constant gain) least-squares learning, for a range of gain parameters. We find that for operational forms of policy rules, i.e. rules that do not depend on contemporaneous values of endogenous aggregate variables, many interest-rate rules do not exhibit robust stability. We consider a variety of interest-rate rules, including instrument rules, optimal reaction functions under discretion or commitment, and rules that approximate optimal policy under commitment. For some reaction functions we allow for an interest-rate stabilization motive in the policy objective. The expectations-based rules proposed in Evans and Honkapohja (2003, 2006) deliver robust learning stability. In contrast, many proposed alternatives become unstable under learning even at small values of the gain parameter.
Keywords: adaptive learning; commitment; determinacy; interest-rate setting; stability
JEL Codes: D84; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expectations-based rules (D84) | robust learning stability (C62) |
| alternatives (Q42) | instability under learning (C62) |
| Taylor rule with strong response to lagged expectations (C54) | instability of REE under learning (C62) |
| policy design (G52) | economic stability (E63) |
| gain parameters (C51) | stability of REE (Q30) |
| eigenvalues within unit circle (C62) | stability condition (C62) |