The effects of learning and signaling on money demand: With an application to heterodox inflation stabilization programs |
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Authors: | Francisco J Ruge-Murcia |
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Institution: | (1) Department of Economics, University of Montreal, C.P. 6128, succursale A, Montreal, PQ H3C 3J7, Canada (e-mail: rugemurf@crde.umontreal.ca), CA |
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Abstract: | This paper develops a nonlinear vector autoregression of inflation and money growth subject to changes in regime. The regimes
are fully characterized by the mean and variance of inflation and are conjectured to be the result of alternative government
policies. Agents are unable to observe directly whether government actions are indeed consistent with the inflation rate targeted
as part of a stabilization program. However, as part of their money demand decision, agents construct probability inferences
regarding the regime. Government announcements are assumed to provide agents with additional, possibly truthful information
regarding the regime.
This specification is estimated using data from the Israeli and Argentine high-inflation periods. Results indicate that the
successful stabilization program implemented in Israel in July 1985 was more credible than either the earlier Israeli attempt
in November 1984 or the Argentine programs. Government's signaling might simplify the agents' inference problem and increase
the speed of their learning but, under certain conditions, it might also increase inflation volatility. Welfare gains from
a temporary increase in real balances might be high enough to induce agents to raise their money demand in the short-term
even if they are uncertain about the nature of government policy and the eventual outcome of the stabilization attempt. Statistically,
the model restrictions cannot be rejected at the 1% significance level.
First version received: August 1998/Final version received: January 1999 |
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Keywords: | : Learning credibility government announcements signaling inflation changes in regime non-linear vector autoregressions money demand |
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