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

Ronald Davies () and Paul Shea ()
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Paul Shea: University of Oregon Economics Department

University of Oregon Economics Department Working Papers from University of Oregon Economics Department

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 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.

Keywords: current account; international debt movements; expectations; adaptive learning. (search for similar items in EconPapers)
JEL-codes: D83 D84 F11 F32 F41 (search for similar items in EconPapers)
Date: 2003-04-10
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