Monetary Policy Under Behavioral Expectations: Theory and Experiment
Tinbergen Institute Discussion Paper 15-087/II
Bank of Lithuania Working Paper 42/2017
69 Pages Posted: 28 Jul 2015 Last revised: 6 Apr 2017
Date Written: July 18, 2015
Abstract
Expectations play a crucial role in modern macroeconomic models. We consider a New Keynesian framework under rational expectations and under a behavioral model of expectation formation. We show how the economy behaves in the alternative scenarios with a focus on inflation volatility. 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. The results support the behavioral model and the claim that output stabilization can lead to less volatile inflation.
Keywords: Behavioral Macroeconomics, Experimental Macroeconomics, Heterogeneous Expectations, LtFE, Trade-off Inflation and Output Gap
JEL Classification: C90, E03, E52, D84
Suggested Citation: Suggested Citation
Matthias Weber
University of St. Gallen - School of Finance ( email )
Unterer Graben 21
St.Gallen, CH-9000
Switzerland
