Monetary Policy Under Behavioral Expectations: Theory and Experiment
52 Pages Posted: 28 Jul 2015 Last revised: 8 Jul 2019
Date Written: September 1, 2015
Expectations play a crucial role in modern macroeconomic models. We consider a New Keynesian framework under a behavioral model of expectation formation and under rational expectations. Contrary to the rational model, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions in a learning-to-forecast experiment. In line with the behavioral model, the results support the claim that output stabilization can lead to less volatile inflation.
Keywords: Behavioral Macroeconomics, Experimental Macroeconomics, Heterogeneous Expectations, Learning-to-Forecast Experiment
JEL Classification: E52, E70, C92, D84
Suggested Citation: Suggested Citation