Frictions, Persistence, and Central Bank Policy in an Experimental Dynamic Stochastic General Equilibrium Economy

54 Pages Posted: 16 Mar 2011 Last revised: 26 Mar 2011

See all articles by Charles N. Noussair

Charles N. Noussair

Tilburg University

Damjan Pfajfar

Board of Governors of the Federal Reserve System

Janos Zsiros

Cornell University

Date Written: March 14, 2011

Abstract

New Keynesian dynamic stochastic general equilibrium models are the principal paradigm currently employed for central bank policy-making. In this paper, we construct experimental economies, populated with human subjects, with the structure of a New Keynesian DSGE model. We give individuals monetary incentives to maximize the objective functions in the model, but allow scope for agents boundedly rational behavior and expectations to influence outcomes. Subjects participate in the roles of consumer/workers, producers, or central bankers. Our objective is twofold. The first objective is general, and is to create an experimental environment for the analysis of macroeconomic policy questions. The second objective is more focused and is to consider several specific research questions relating to the persistence of shocks, the behavior of human central bankers, and the pricing behavior of firms, using our methodology. We find that the presence of menu costs is not necessary to generate persistence of output shocks, but rather that monopolistic competition in the output market is sufficient. Interest rate policies of human discretionary central bankers are characterized by persistence in interest rate shocks, the use of the Taylor principle, and lower output and welfare than under an automated instrumental rule. Patterns in price changes conform closely to stylized empirical facts.

Keywords: Experimental Economics, DSGE economy, Monetary Policy, Menu costs

JEL Classification: C91, C92, E31, E32

Suggested Citation

Noussair, Charles N. and Pfajfar, Damjan and Zsiros, Janos, Frictions, Persistence, and Central Bank Policy in an Experimental Dynamic Stochastic General Equilibrium Economy (March 14, 2011). TILEC Discussion Paper No. 2011-030; European Banking Center Discussion Paper No. 2011-006. Available at SSRN: https://ssrn.com/abstract=1785407 or http://dx.doi.org/10.2139/ssrn.1785407

Charles N. Noussair

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC 5000 LE
Netherlands

Damjan Pfajfar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

Janos Zsiros

Cornell University ( email )

Ithaca, NY 14853
United States

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