Equilibrium selection, observability and backward-stable solutions

Abstract

The robustness of stability under learning to observability of exogenous shocks is examined. Regardless of observability assumptions, the minimal state variable solution is robustly stable under learning provided the expectational feedback is not both positive and large, while the nonfundamental solution is never robustly stable. Overlapping generations and New Keynesian models are considered and concerns raised in [Cochrane, J., 2011. Determinacy and identification with Taylor rules. Journal of Political Economy 119, 565-615, Cochrane, J., 2017. The new-Keynesian liquidity trap. Journal of Monetary Economics, forthcoming.] are addressed.