Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory

CentER Discussion Paper Series No. 2011-091

62 Pages Posted: 26 Jan 2009 Last revised: 15 Aug 2011

See all articles by Damjan Pfajfar

Damjan Pfajfar

Board of Governors of the Federal Reserve System

Blaz Zakelj

Universitat Pompeu Fabra

Date Written: July 17, 2011

Abstract

Using laboratory experiments within a New Keynesian macro framework, we explore the formation of inflation expectations and its interaction with monetary policy design. The central question in this paper is how to design monetary policy in the environment characterized by heterogeneous expectations. Rules that use actual rather than forecasted inflation produce lower inflation variability and alleviate expectational cycles. Degree of responsiveness to deviations of inflation from its target in the Taylor rule produces nonlinear effects on inflation variability. We also provide considerable support for the existence of heterogeneity of inflation expectations and show that a significant proportion of subjects are rational in our experiment. However, most subjects rather than using a single model they tend to switch between alternative models.

Keywords: Laboratory Experiments, Inflation Expectations, New Keynesian Mode, Monetary Policy Design

JEL Classification: C91, C92, E37, E52

Suggested Citation

Pfajfar, Damjan and Zakelj, Blaz, Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory (July 17, 2011). CentER Discussion Paper Series No. 2011-091. Available at SSRN: https://ssrn.com/abstract=1332982 or http://dx.doi.org/10.2139/ssrn.1332982

Damjan Pfajfar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Blaz Zakelj

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain
+34 93 542 1998 (Phone)
+34 93 542 2533 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
175
Abstract Views
2,535
rank
175,405
PlumX Metrics