BANK OF FINLAND
DISCUSSION PAPERS
29 · 2002
George W. Evans – Seppo Honkapohja
Research Department
4.12.2002
Adaptive learning and
monetary policy design
Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag
Suomen Pankki Bank of Finland P.O.Box 160 FIN-00101 HELSINKI Finland ( (( ( + 358 9 1831
BANK OF FINLAND
DISCUSSION PAPERS
29 · 2002
George W. Evans* – Seppo Honkapohja**
Research Department
4.12.2002
Adaptive learning and
monetary policy design
The views expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland.
* University of Oregon
** University of Helsinki and Bank of Finland
Presented at the 2002 Journal of Money, Credit and Banking Conference on Recent Developments in Monetary Macroeconomics. We thank John Duffy and Tom Sargent for their comments. Financial support from US National Science Foundation, the Academy of Finland, Yrjö Jahnsson Foundation, Bank of Finland and Nokia Group is gratefully acknowledged.
Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag
http://www.bof.fi ISBN 952-462-021-9 ISSN 0785-3572 (print) ISBN 952-462-022-7 ISSN 1456-6184 (online)
3
Adaptive learning and monetary policy design
Bank of Finland Discussion Papers 29/2002
George W. Evans – Seppo Honkapohja Research Department
Abstract
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. Key words: commitment, interest rate setting, adaptive learning, stability, determinacy, expectations shocks
Adaptiivinen oppiminen ja rahapolitiikan muotoilu
Suomen Pankin keskustelualoitteita 29/2002
George W. Evans – Seppo Honkapohja Tutkimusosasto
Tiivistelmä
Tutkimuksessa luodaan aluksi katsaus uusimpaan korkosääntöjä käsittelevään tut-kimukseen, jossa korostetaan politiikan muotoilua siten, että sen avulla saavute-taan talouden stabiliteetti yksityisen sektorin oppimiskäyttäytymisen suhteen. Oikealla tavalla muotoillut, ennusteisiin perustuvat korkosäännöt voivat johtaa optimaaliseen tasapainoon, joka on sekä determinoitu että oppimisen suhteen sta-biili. Joillakin instrumenttisäännöillä ja likimääräisillä tavoitesäännöillä on myös nämä toivottavat ominaisuudet. Tutkimuksessa tarkastellaan myös optimaalisen politiikan toteutukseen liittyviä ongelmia. Näitä ovat keskeisten muuttujien ha-vaittavuus ja tarvittava tietämys talouden rakenneparametrien arvoista. Lisäksi tarkastellaan odotuksissa esiintyvien, muiden kuin oppimisesta aiheutuvien sok-kien seurauksia.
Avainsanat: sitoutuminen, korkojen asetanta, adaptiivinen oppiminen, stabiilisuus, determinoituvuus, odotussokit
5
Contents
Abstract ...3
1 Introduction ...7
2 The model...8
3 Determinacy and stability under learning ...12
3.1 General methodology ...13
3.2 Results for monetary policy...15
4 Operationality...18
4.1 Observability of private expectations ...18
4.2 Non-observability of current data...20
5 Expectation shocks ...21
6 Estimation of structural parameters ...24
7 Conclusions ...26
Appendix 1 Derivation of optimal REE and the fundamentals based it rule.28 Appendix 2 Welfare calculation...29
Appendix 3 Convergence under structural estimation ...30
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Hydqv/ J1 Z1+5334,= H{shfwdwlrqv lq Hfrqrplfv= Dgdswlyh yhuvxv Hgxfwlyh Ohduqlqj/ Uhyxh Hfrqrpltxh/ 85/ 8:68;51
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BANK OF FINLAND DISCUSSION PAPERS
ISSN 0785-3572, print; ISSN 1456-6184, online
1/2002 Tuomas Välimäki Bidding in fixed rate tenders: theory and experience with
the ECB tenders. 2002. 45 p. ISBN 951-686-763-4, print;
ISBN 951-686-764-2, online. (TU)
2/2002 Juha Junttila Forecasting the macroeconomy with current financial market
information: Europe and the United States. 2002. 70 p.
ISBN 951-686-765-0, print; ISBN 951-686-766-9, online. (TU)
3/2002 Seppo Honkapohja – Kaushik Mitra Performance of monetary policy with
internal central bank forecasting. 2002. 44 p. ISBN 951-686-767-7, print;
ISBN 951-686-768-5, online. (TU)
4/2002 Iftekhar Hasan – Markku Malkamäki – Heiko Schmiedel Technology,
automation, and productivity of stock exchanges: International evidence.
2002. 41 p. ISBN 951-686-769-3, print; ISBN 951-686-770-7, online. (TU) 5/2002 Vesa Kanniainen – Mikko Leppämäki Financial institutions and the
allocation of talent. 2002. 23 p. ISBN 951-686-771-5, print;
ISBN 951-686-772-3, online. (TU)
6/2002 Anne Brunila – Marco Buti – Jan in’t Veld Cyclical stabilisation under the
Stability and Growth Pact: How effective are automatic stabilisers? 2002.
33 p. ISBN 951-686-773-1 print; ISBN 951-686-774-X, online. (KT)
7/2002 Anne Brunila Fiscal policy: Coordination, discipline and stabilisation. 2002. 24 p. ISBN 951-686-775-8 print; ISBN 951-686-776-6, online. (KT)
8/2002 Ari Hyytinen – Iikka Kuosa – Tuomas Takalo Law or finance: Evidence from
Finland. 2002. 57 p. ISBN 951-686-777-4, print; ISBN 951-686-778-2, online.
(TU)
9/2002 Bill F. Francis – Iftekhar Hasan – Delroy M. Hunter Returns and volatility
linkages in the international equity and currency markets. 2002. 36 p.
ISBN 951-686-779-0, print; ISBN 951-686-780-4, online. (TU)
10/2002 Heli Paunonen – Hanna Jyrkönen Cash usage in Finland – How much can be
explained? 2002. 33 p. ISBN 951-686-781-2, print; ISBN 951-686-782-0,
11/2002 Heiko Schmiedel Total factor productivity growth in European stock
exchanges: A non-parametric frontier approach. 2002. 37 p.
ISBN 951-686-783-9, print; ISBN 951-686-784-7, online. (TU)
12/2002 Leena Mörttinen Banking sector output and labour productivity in six
European countries. 2002. 73 p. ISBN 951-686-785-5, print;
ISBN 951-686-786-3, online. (TU)
13/2002 Pertti Pylkkönen Riskirahastot. 2002. 44 p. ISBN 951-686-787-1, print; ISBN 951-686-788-X, online. (RM)
14/2002 Tapio Pohjola Effects of fiscal policy on the durability of low inflation
regimes. 2002. 30 p. ISBN 951-686-789-8, print; ISBN 951-686-790-1, online.
(TU)
15/2002 Iftekhar Hasan – Sudipto Sarkar Banks’ option to lend, interest rate
sensitivity, and credit availability. 2002. 54 p. ISBN 951-686-791-X, print;
ISBN 951-686-792-8, online. (TU)
16/2002 Matti Keloharju – Markku Malkamäki – Kjell G. Nyborg – Kristian Rydqvist
A descriptive analysis of the Finnish treasury bond market. 2002. 26 p.
ISBN 951-686-793-6, print; ISBN 951-686-794-4, online. (TU)
17/2002 Mikko Niskanen Lender of last resort and the moral hazard problem. 2002. 32 p. ISBN 951-686-795-2, print; ISBN 951-686-796-0, online. (TU)
18/2002 George W. Evans – Seppo Honkapohja Policy interaction, learning and the
fiscal theory of prices. 2002. 28 p. ISBN 951-686-797-9, print;
ISBN 951-686-798-7, online. (TU)
19/2002 Kenneth Leong Reconciling the New Keynesian model with observed
persistence. 2002. 29 p. ISBN 951-686-799-5, print; ISBN 952-462-000-6,
online. (TU)
20/2002 Maritta Paloviita Inflation dynamics in the euro area and the role of
expectations. 2002. 39 p. ISBN 952-462-003-0, print; ISBN 952-462-004-9,
online. (TU)
21/2002 Markku Lanne Nonlinear dynamics of interest rate and inflation. 2002. 27 p. ISBN 952-462-005-7, print; ISBN 952-462-006-5, online. (TU)
22/2002 Jouko Vilmunen Dynamics of investment behaviour in Finland: aggregate
and firm level evidence. 2002. 30 p. ISBN 952-462-007-3, print;
ISBN 952-462-008-1, online. (TU)
23/2002 Harry Leinonen Settlement in modern network-based payment
infrastructures – description and prototype of the E-Settlement model.
2002. 168 p. ISBN 952-462-009-X, print; ISBN 952-462-010-3, online. (RM) 24/2002 Tuomas Välimäki Variable rate liquidity tenders. 2002. 45 p.
ISBN 952-462-011-1, print; ISBN 952-462-012-X, online. (TU)
25/2002 Peik Granlund Bank exit legislation in US, EU and Japanese financial
centres. 2002. 103 p. ISBN 952-462-013-8, print; ISBN 952-462-014-6, online.
(TU)
26/2002 Heiko Schmiedel – Markku Malkamäki – Juha Tarkka Economies of scale and
technological development in securities depository and settlement systems.
2002. 33 p. ISBN 952-462-015-4, print; ISBN 952-462-016-2, online. (TU) 27/2002 Karlo Kauko Links between securities settlement systems: An oligopoly
theoretic approach. 2002. 29 p. ISBN 952-462-017-0, print;
ISBN 952-462-018-9, online. (TU
28/2002 Helvi Kinnunen Väestön vanheneminen, työmarkkinat ja julkisen talouden
näkymät. 2002. 27 p. ISBN 952-462-019-7, print; ISBN 952-462-020-09,
online. (KT)
29/2002 George W. Evans – Seppo Honkapohja Adaptive learning and monetary
policy design. 2002. 34 p. ISBN 952-462-021-9, print; ISBN 952-462-022-7,
