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).…”

On the external validity of experimental inflation forecasts: A comparison with five categories of field expectations

“…Other closely related LtFEs includeAssenza et al (2013),Arifovic and Petersen (2017) andMauersberger (2018). 7 While a full model (e.g., inNoussair et al (2015)) generates payoffs in line with microfoundations and economic agents' roles in reality (in so far as subjects represent consumers and producers who directly interact on the product and labour markets), forecasts are complicated to elicit from subjects' tasks.…”

Inspired and inspiring: Hervé Moulin and the discovery of the beauty contest game

“…Such models can foster new links between theorists with great modeling tools and experimenters with equally useful tools, selecting empirically relevant behaviors in the two cases of indeterminacy, through multiple equilibria or multiple bounded rational reasoning procedures. There is already such a small but growing and fruitful interaction in macroeconomics (see survey by Duffy (2016), and on experiments featuring beauty contest elements in particular (e.g., Benhabib et al, 2016, or in new Keynesian models as in Pfajfer and Zakelj, 2011, Hommes and Zhu, 2014, Mauersberger, 2016. You should receive the famous No.…”