Monetary policy rules in a non-rational world: A macroeconomic experiment

Abstract

I introduce a new learning-to-forecast experimental design, where subjects in a virtual New-Keynesian macroeconomy based on Woodford (2013) need to forecast individual instead of aggregate outcomes. This approach is motivated by the critique of Preston (2005) and Woodford (2013) that substituting arbitrary forms of expectations into the reduced-form New-Keynesian model (consisting of the "DIS" equation, the "Phillips curve" and the "Taylor" rule) is inconsistent with its microfoundations. Using this design, I analyze the impact of di↵erent interest rate rules on expectation formation and expectation-driven fluctuations.Even if the Taylor principle is fulfilled, instead of quickly converging to the REE, the experimental economy exhibits persistent purely expectation-driven fluctuations not necessarily around the REE. Only a particularly aggressive monetary authority achieves the elimination of these fluctuations and quick convergence to the REE. To explain the aggregate behavior in the experiment, I develop a "noisy" adaptive learning approach, introducing endogenous shocks into a simple adaptive learning model. However, I find that for some monetary policy regimes a reinforcement learning model, applied to di↵erent forecasting rules, provides a better fit to the data.

Central Bank Communication that Works: Lessons from Lab Experiments

“…Our framework is a learning-to-forecast (LTF) experiment based on an extended version of Woodford's (2013) model of heterogeneous expectations and monetary policy. The New Keynesian model with heterogeneous expectations was rst introduced in the lab by Mauersberger (2017). In the LTF setup, participants provide incentivized period-by-period forecasts that are used as stand-ins for households' and rms' expectations.…”

“…Excessive volatility of individual forecasts is well-documented in LTF literature, especially in heterogeneous expectations environments(Pfajfar and akelj, 2016;Mauersberger, 2017).…”

Exploring a Dualism of Human Rationality: Experimental Study of a Cheating Contest Game

“…She corroborates a finite depth of reasoning, mainly first-or second-order beliefs. Yet, the convergence to the Nash equilibrium occurs due to learning theories [12,[17][18][19].…”

Macroeconomic expectations, central bank communication, and background uncertainty: A COVID-19 laboratory experiment

“…(2013) ; Hommes et al. (2019b) ; Pfajfar, Žakelj, 2014 , Pfajfar, Žakelj, 2018 , and Mauersberger (2021) ).…”