Impacts of priors on convergence and escapes from Nash inflation

Recent papers have analyzed how economies with adaptive agents may converge to and escape from self-confirming equilibria. These papers have imputed to agents a particular prior about drifting coefficients. In the context of a model of monetary policy, this paper analyzes dynamics that govern both convergence and escape under a more general class of priors for the government. We characterize how the shape of the prior influences possible cycles, convergence, and escapes. There are priors for which the E-stability condition is not enough to assure local convergence to a self-confirming equilibrium. Our analysis also isolates the source of differences in the sustainability of Ramsey inflation encountered in the analyses of Sims [Revista de Analisis Economico 3 (1988) 3] and Chung [PhD Thesis, University of Minnesota, 1990], on the one hand, and Cho, Williams, and Sargent [Rev. Econ. Stud. 69 (2002) 1], on the other. (c) 2005 Elsevier Inc. All rights reserved.