Setting expectations

Evans and Honkapohja’s work on learning in macro is important. Watch this to get a sense for what they’re doing:

But learning dynamics are not well understood empirically. Prof. Evans describes the dynamics under adaptive learning. Under rational expectations the economy would just pop to the good equilibrium. Under other learnings schemes the dynamics would be different. How do we know which dynamics describe the actual economy? We’d need to have empirical tests of the different learning regimes. We don’t have these tests.

In the same vein, Prof. Evans is just speculating about where the economy is right now in the phase diagram. He suggest we’re close to to the deflationary zone where things go to hell if the Fed raises interest rates. In fact, there’s no a priori way to know where we’re at in the diagram — we don’t have good measures of expectations.

(ht Thoma. BTW, Thoma says that Evan’s model shows increasing interest rates “increases rather than decreases the chance of a deflationary spiral”. They do no such thing. The little arrows on the phase diagram aren’t invariant to policy, see the paper figure 1. Suppose you’re close to the deflationary zone. Where you were before the policy may be in the deflationary zone after the policy, but your location after the policy is determined, in part, by the policy and it doesn’t have to be in the deflationary zone. Anyway, this probability could be computed as simulated comparative static, but Evan’s didn’t do this in his paper.)

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