The New Keynesian theory of inflation determination is tested in this paper by means of laboratory experiments. We find that the Taylor principle is a necessary condition to ensure convergence to the inflation target, but it is not sufficient. Using a behavioral model of expectation formation, we show how heterogeneous expectations tend to self-organize on different forecasting strategies depending on monetary policy. Finally, we link the central bank ability to control inflation to the impact that monetary policy has on the type of feedback -positive or negative-between expectations and realizations of aggregate variables and in turn on the composition of subjects with respect to the type of forecasting rules they use.

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Expectations play a crucial role in finance, macroeconomics, monetary economics and fiscal policy. In the last decade a rapidly increasing number of laboratory experiments have been performed to study individual expectation formation, the interactions of individual forecasting rules and the aggregate macro behavior they co-create. The aim of this chapter is to provide a comprehensive literature survey on laboratory experiments on expectations in macroeconomics and finance. In particular, we discuss the extent to which expectations are rational or may be described by simple forecasting heuristics, at the individual as well as the aggregate level.