The impact of interest rate policy on individual expectations and asset bubbles in experimental markets

Monetary policy obeying the Taylor principle turns prices into strategic substitutes

“…By providing the theoretical conditions under which monetary policy effectively turns a context of strategic complements into a context of strategic substitutes, our results complement the conclusion reached by Hommes (2018, p. 84), according to which " [t]he laboratory macro experiments also suggest an immediate way to stabilize the economy: policy can stabilize the economy by adding negative feedback to the system, or equivalently, by weakening the positive feedback." Our results can also rationalize why monetary policy is found to be effective in a variety of monetary policy experiments, like Assenza et al (2013), Bao and Zong (2019), Pfajfar and Žakelj (2018), Hennequin and Hommes (2019), and Hommes et al (2019).…”

Managing Bubbles in Experimental Asset Markets with Monetary Policy

“…So far, there is little experimental work on monetary policy and asset price bubbles, with three notable exceptions. 6 Simultaneously but independently, Bao and Zong (2019) investigate the impact of an interest rate change on asset price bubbles in a learning-to-forecast experiment. They use a simple policy rule that substantially raises or cuts the interest rate when the asset price reaches a certain threshold, and find that this policy effectively stabilizes prices.…”

Expectation formation in finance and macroeconomics: A review of new experimental evidence

“…Similarly, Giusti et al (2016) concluded that introducing the opportunity cost of speculation in the form of interest payment to cash has limited success in mitigating bubbles. Bao and Zong (2019) conducted a LtFE where the REE of the asset price is 60. The initial interest rate for the risk-free asset is 5%.…”

“…(5) Traditionally, LtFEs mainly study questions related to asset pricing. Recent LtFEs pay more attention to monetary economics and the role of monetary policy in asset markets (e.g., Arifovic and Petersen, 2017;Arifovic et al, 2019;Assenza et al, 2019;Bao and Zong, 2019;Hommes et al, 2019a,b;Mauersberger, 2019;Ahrens et al, 2019). The findings of this literature show that higher interest rates and central bank communication are useful in stabilizing asset prices or inflation rates.…”