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Two-sided Learning and Optimal Open Economy Monetary Policy

Timothy Kam

No 81, Econometric Society 2004 Australasian Meetings from Econometric Society

Abstract: In this paper, we consider a dynamic New Keynesian model of the small open economy in the light of bounded rationality. This entails private agents and the central bank updating their beliefs about the laws of motion of inflation, the output gap and real exchange rate when forming their optimal decisions. It is shown that a fundamental-shock representation of optimal discretionary policy in the small open economy will yield multiple REE, and in particular, the fundamentals REE cannot be achieved under expectational learning. The alternative representation of optimal policy - an open-economy forecast-based rule - yields a stable fundamentals REE only under certain parameterization when agents learn. Furthermore, the Taylor principle need not be satisfied because part of the stabilization is carried out by the real-exchange-rate channel

Keywords: : Statistical learning; Optimal monetary policy; New Open Economy; Stability (search for similar items in EconPapers)
JEL-codes: D83 E52 F41 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-cba
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Citations: View citations in EconPapers (3)

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