Monetary Policy under Behavioral Expectations: Theory and Experiment

Cars Hommes, Domenico Massaro and Matthias Weber

No 15-087/II, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: Expectations play a crucial role in modern macroeconomic models. We replace the common assumption of rational expectations in a New Keynesian framework by the assumption that expectations are formed according to a heuristics switching model that has performed well in earlier work. We show how the economy behaves under these assumptions with a special focus on inflation volatility. Contrary to comparable models based on full rationality, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions with a learning to forecast experiment. The experimental results support the behavioral model and the claim that reacting to the output gap in addition to inflation can indeed lower inflation volatility.

Keywords: Experimental Macroeconomics; Heterogeneous Expectations; Learning to forecast Experiment; Trade-off Inflation and Output Gap (search for similar items in EconPapers)
JEL-codes: C90 D84 E03 E52 (search for similar items in EconPapers)
Date: 2015-07-27
New Economics Papers: this item is included in nep-cba, nep-exp, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Downloads: (external link)
https://papers.tinbergen.nl/15087.pdf (application/pdf)

Related works:
Journal Article: Monetary policy under behavioral expectations: Theory and experiment (2019)
Working Paper: Monetary Policy under Behavioral Expectations: Theory and Experiment (2017)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20150087

Access Statistics for this paper

More papers in Tinbergen Institute Discussion Papers from Tinbergen Institute Contact information at EDIRC.
Bibliographic data for series maintained by Tinbergen Office +31 (0)10-4088900 ().