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Expectations and Monetary Policy: Experimental Evidence

Oleksiy Kryvtsov () and Luba Petersen ()

Staff Working Papers from Bank of Canada

Abstract: The effectiveness of monetary policy depends, to a large extent, on market expectations of its future actions. In a standard New Keynesian business-cycle model with rational expectations, systematic monetary policy reduces the variance of inflation and the output gap by at least two-thirds. These stabilization benefits can be substantially smaller if expectations are non-rational. We design an economic experiment that identifies the contribution of expectations to macroeconomic stabilization achieved by systematic monetary policy. We find that, despite some non-rational component in expectations formed by experiment participants, monetary policy is quite potent in providing stabilization, reducing macroeconomic variance by roughly half.

Keywords: Business fluctuations and cycles; Monetary policy implementation; Transmission of monetary policy (search for similar items in EconPapers)
JEL-codes: C9 D84 E3 E52 (search for similar items in EconPapers)
Pages: 70 pages
Date: 2013
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:13-44

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