Learning and international transmission of shocks

Author name: 
McKibbin WJ
Tan KY

This paper studies the implications of adaptive learning in the modelling of inter-country linkages in a two-region MSG-Cubed (MSG3) model built on micro-founded behaviors of firms and households. The nature of the transmission process under rational expectations versus the adaptive learning methodology (Evans and Honkapohja, 2001) is explored. We investigate the propagation mechanism within and across borders for various shocks and policy changes within the United States: change in inflation target, fiscal policy, productivity shock, and rise in equity risk. Adaptive learning is found to change the short run sign of transmission in all cases except for the inflation target shock. Learning could also resolve the quantity anomaly puzzle in the international RBC literature. The findings suggest the choice of expectations formation scheme is crucial in large-scale macroeconomic models.

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