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Rethinking ExpectationsThe Way Forward for Macroeconomics$
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Roman Frydman and Edmund S. Phelps

Print publication date: 2013

Print ISBN-13: 9780691155234

Published to Princeton Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691155234.001.0001

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Learning as a Rational Foundation for Macroeconomics and Finance

Learning as a Rational Foundation for Macroeconomics and Finance

(p.68) Chapter Two Learning as a Rational Foundation for Macroeconomics and Finance
Rethinking Expectations

George W. Evans

Seppo Honkapohja

Princeton University Press

This chapter examines the central ideas about learning and bounded rationality for macroeconomics and finance. It first introduces the main methodological issues concerning expectation formation and learning before discussing the circumstances in which rational expectations may arise. It then reviews empirical work that applies learning to macroeconomic issues and asset prices, along with the implications of the use of structural knowledge in learning and the form of the agents' decision rules. As an application, the scope of Ricardian Equivalence is considered. The chapter also presents three applications of the learning approach to monetary policy: the appropriate specification of interest rate rules; implementation of price-level targeting to achieve learning stability of the optimal rational expectations equilibrium; and whether under learning, commitment to price-level targeting can be sufficient to rule out the deflation trap of a zero interest rate lower bound and return the economy to the intended rational expectations steady state.

Keywords:   learning, bounded rationality, macroeconomics, finance, expectation formation, rational expectations, asset prices, Ricardian Equivalence, monetary policy, rational expectations equilibrium

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