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
Date Written: July 17, 2011
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: Suggested Citation