Adaptive learning in regime-switching models
By: William A. Branch, Troy Davig, Bruce McGough.
Contributors: Davig, Troy.; McGough, Bruce.; Federal Reserve Bank of Kansas City. Research Division.
Series: RWP -- 07-09
Publisher: Research Division, Federal Reserve Bank of Kansas City
Published: 2007
Place of publication: Kansas City [Mo.]
Language: eng
Format: Electronic resource
Description: This paper studies adaptive learning in economic environments subject to recurring structural  change. Stochastically evolving institutional and policy-making features can be described by regime-switching rational expectations models whose parameters evolve according to a finite state Markov process. We demonstrate that in non-linear models of this form, two natural schemes emerge for learning the conditional means of endogenous variables: under mean value learning, the equilibrium's lag structure is assumed exogenous and therefore known to agents; whereas, under vector autoregession learning (VAR learning), the equilibrium lag structure depends endogenously on agents' beliefs and must be learned. We show that an intuitive condition, analogous to the 'Long-run Taylor Principle' of Davig and Leeper (2007), ensures convergence to a regime-switching rational expectations equilibrium. However, the stability of sunspot equilibria, when they exist, depends on whether agents adopt mean value or VAR learning. Coordinating on sunspot equilibria via a VAR learning rule is not possible. These results show that, when assessing the plausibility of rational expectations equilibria in non-linear models, out of equilibrium behavior is important.
Notes: Title from PDF file (viewed on Oct. 10, 2008).

"November 2007; revised June 2008."

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