Monetary Policy Under Behavioral Expectations: Theory and Experiment

52 Pages Posted: 28 Jul 2015 Last revised: 8 Jul 2019

See all articles by Cars H. Hommes

Cars H. Hommes

Government of Canada - Bank of Canada; CeNDEF, Amsterdam School of Economics, University of Amsterdam; Tinbergen Institute

Domenico Massaro

Catholic University of Milan; University of Amsterdam - CeNDEF

Matthias Weber

University of St. Gallen - School of Finance; Swiss Finance Institute

Date Written: September 1, 2015

Abstract

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

Hommes, Cars H. and Massaro, Domenico and Weber, Matthias, Monetary Policy Under Behavioral Expectations: Theory and Experiment (September 1, 2015). European Economic Review, 2019, 118:193–212, Available at SSRN: https://ssrn.com/abstract=2636234 or http://dx.doi.org/10.2139/ssrn.2636234

Cars H. Hommes (Contact Author)

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

CeNDEF, Amsterdam School of Economics, University of Amsterdam ( email )

Roetersstraat 11
Amsterdam, NL-1018WB
Netherlands

HOME PAGE: http://https://www.uva.nl/en/profile/h/o/c.h.hommes/c.h.hommes.html

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Domenico Massaro

Catholic University of Milan ( email )

Largo Gemelli, 1
Via Necchi 9
Milan, MI 20123
Italy

University of Amsterdam - CeNDEF ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Matthias Weber

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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