Monetary Policy under Behavioral Expectations: Theory and Experiment
Cars Hommes (),
Domenico Massaro and
No 42, Bank of Lithuania Working Paper Series from Bank of Lithuania
Expectations play a crucial role in modern macroeconomic models. We consider a New Keynesian framework under rational expectations and under a behavioral model of expectation formation. We show how the economy behaves in the alternative scenarios with a focus on inflation volatility. Contrary to the rational model, 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 in a learning-to-forecast experiment. The results support the behavioral model and the claim that output stabilization can lead to less volatile inflation.
Keywords: Experimental macroeconomics; Heterogeneous expectations; LtFE; Tradeoff inflation and output gap (search for similar items in EconPapers)
JEL-codes: C90 E03 E52 D84 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-cbe, nep-dge, nep-exp, nep-mac and nep-mon
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Working Paper: Monetary Policy under Behavioral Expectations: Theory and Experiment (2015)
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