Adaptive Learning and Multiple Equilibria in a Natural Rate Monetary Model with Unemployment Persistence

This paper demonstrates that the adaptive learning approach to modelling private sector expectations can be used as an equilibrium selection mechanism in a natural-rate monetary model with unemployment persistence. In particular, it is shown that only one of the two rational expectations equilibria is stable under least-squares learning, and that it is always the low-inflation equilibrium with intuitive comparative statics properties that is the learnable equilibrium. Hence, this paper provides a basic theoretical justification for focusing on the low-inflation equilibrium. Earlier contributions, in which the high-inflation equilibrium was ignored, mainly because of its unpleasant characteristics, are not theoretically satisfactory.