Stabilizing Expectations at the Zero Lower Bound: Experimental Evidence

91 Pages Posted: 22 Feb 2016 Last revised: 12 Apr 2017

See all articles by Jasmina Arifovic

Jasmina Arifovic

Simon Fraser University (SFU) - Department of Economics

Luba Petersen

Simon Fraser University (SFU) - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 1, 2017

Abstract

Our study demonstrates how agents' expectations can interact dynamically with monetary and fiscal policy at the zero lower bound. We study expectation formation near the zero lower bound using a learning-to-forecast laboratory experiment under alternative policy regimes. In our experimental economy, monetary policy targets inflation around a constant or state-dependent target. We find that subjects' expectations significantly over-react to stochastic aggregate demand shocks and historical information, leading many economies to experience severe deflationary traps. Neither quantitatively nor qualitatively communicating the state-dependent inflation targets reduce the duration or severity of economic crises. Introducing anticipated and persistent fiscal stimulus at the zero lower bound reduces the severity of the recessions. When the recovery of fundamentals is sufficiently slow, participants' expectations become highly pessimistic and neither monetary nor fiscal policy are effective at stabilizing the economy.

Keywords: monetary policy, expectations, zero lower bound, learning to forecast, communication, laboratory experiment

JEL Classification: C92, E2, E52, D50, D91

Suggested Citation

Arifovic, Jasmina and Petersen, Luba, Stabilizing Expectations at the Zero Lower Bound: Experimental Evidence (April 1, 2017). Available at SSRN: https://ssrn.com/abstract=2735651 or http://dx.doi.org/10.2139/ssrn.2735651

Jasmina Arifovic

Simon Fraser University (SFU) - Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada
604-291-3508 (Phone)
604-291-5944 (Fax)

Luba Petersen (Contact Author)

Simon Fraser University (SFU) - Department of Economics ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

HOME PAGE: http://www.sfu.ca/~lubap

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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