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Experimental evidence on the persistence of output and inflation

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Author Info
Klaus Adam () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany)

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Abstract

This paper presents experimental evidence from a monetary sticky price economy in which output and inflation depend on expected future inflation. With rational inflation expectations, the economy does not generate persistent deviations of output and inflation in response to a monetary shock. In the experimental sessions, however, output and inflation display considerable persistence and regular cyclical patterns. Such behavior emerges because subjects’ inflation expectations fail to be captured by rational expectations functions. Instead, a Restricted Perceptions Equilibrium (RPE), which assumes that agents use optimal but ’simple’ forecast functions, describes subjects’ inflation expectations surprisingly well and explains the observed behavior of output and inflation.

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Publisher Info
Paper provided by European Central Bank in its series Working Paper Series with number 492.

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Length: 60 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:ecb:ecbwps:20050492

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Related research
Keywords: Experiments; Output and Inflation Dynamics; Restricted Perceptions Equilibrium; Rational Expectations.;

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation
C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-44, October. [Downloadable!] (restricted)
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  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," Econometrica, Econometric Society, vol. 68(5), pages 1151-1180, September.
    Other versions:
  4. Nelson, E., 1998. "Sluggish inflation and optimizing models of the business cycle," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 303-322, July. [Downloadable!] (restricted)
  5. Klaus Adam, 2003. "Learning and Equilibrium Selection in a Monetary Overlapping Generations Model with Sticky Prices," Review of Economic Studies, Blackwell Publishing, vol. 70(4), pages 887-907, October. [Downloadable!] (restricted)
    Other versions:
  6. Sunder, S., 1992. "Experimental Asset Markets: A Survey," GSIA Working Papers 1992-19, Carnegie Mellon University, Tepper School of Business.
  7. Marimon, Ramon & Sunder, Shyam, 1993. "Indeterminacy of Equilibria in a Hyperinflationary World: Experimental Evidence," Econometrica, Econometric Society, vol. 61(5), pages 1073-107, September. [Downloadable!] (restricted)
    Other versions:
  8. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09. [Downloadable!] (restricted)
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  9. Evans, George W & Ramey, Garey, 1992. "Expectation Calculation and Macroeconomic Dynamics," American Economic Review, American Economic Association, vol. 82(1), pages 207-24, March. [Downloadable!] (restricted)
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June. [Downloadable!] (restricted)
    Other versions:
  12. Smith, Vernon L & Suchanek, Gerry L & Williams, Arlington W, 1988. "Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets," Econometrica, Econometric Society, vol. 56(5), pages 1119-51, September. [Downloadable!] (restricted)
  13. Schmalensee, Richard, 1976. "An Experimental Study of Expectation Formation," Econometrica, Econometric Society, vol. 44(1), pages 17-41, January. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Heemeijer, P. & Hommes, C.H. & Sonnemans, J. & Tuinstra, J., 2006. "Price Stability and Volatility in Markets with Positive and Negative Expectations Feedback: An Experimental Investigation," CeNDEF Working Papers 06-05, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance. [Downloadable!]
    Other versions:
  2. Damjan Pfajfar & Emiliano Santoro, 2007. "Heterogeneity, Asymmetries and Learning in InfIation Expectation Formation: An Empirical Assessment," Money Macro and Finance (MMF) Research Group Conference 2006 123, Money Macro and Finance Research Group. [Downloadable!]
  3. Vivien Lewis & Agnieszka Markiewicz, 2009. "Model misspecification, learning and the exchange rate disconnect puzzle," Research series 200907-01, National Bank of Belgium. [Downloadable!]
    Other versions:
  4. Fabio Milani, 2005. "Adaptive Learning and Inflation Persistence," Working Papers 050607, University of California-Irvine, Department of Economics. [Downloadable!]
    Other versions:
  5. Michael W.M. Roos & Wolfgang J. Luhan, 2008. "Are Expectations Formed by the Anchoring-and-adjustment Heuristic? – An Experimental Investigation," Ruhr Economic Papers 0054, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen. [Downloadable!]
  6. Eran Guse, 2007. "Learning in a Misspecified Multivariate Self-Referential Linear Stochastic Model," Money Macro and Finance (MMF) Research Group Conference 2006 71, Money Macro and Finance Research Group. [Downloadable!]
    Other versions:
  7. Anufriev, M. & Assenza, T. & Hommes, C.H. & Massaro, D., 2008. "Interest Rate Rules with Heterogeneous Expectations," CeNDEF Working Papers 08-08, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance. [Downloadable!]
  8. Wiliam Branch & George W. Evans, 2005. "Model Uncertainty and Endogenous Volatility," University of Oregon Economics Department Working Papers 2005-21, University of Oregon Economics Department, revised 26 Oct 2006. [Downloadable!]
    Other versions:
  9. Hommes, C.H., 2007. "Bounded Rationality and Learning in Complex Markets," CeNDEF Working Papers 07-01, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance. [Downloadable!]
  10. Michael W.M. Roos & Wolfgang J. Luhan, 2008. "As if or What? – Expectations and Optimization in a Simple Macroeconomic Environment," Ruhr Economic Papers 0055, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen. [Downloadable!]
  11. Cars Hommes & Thomas Lux, 2008. "Individual Expectations and Aggregate Behavior in Learning to Forecast Experiments," Kiel Working Papers 1466, Kiel Institute for the World Economy. [Downloadable!]
  12. George W. Evans & Seppo Honkapohja, 2008. "Learning and Macroeconomics," University of Oregon Economics Department Working Papers 2008-3, University of Oregon Economics Department. [Downloadable!]
  13. Mikhail Anufriev & Tiziana Assenza & Cars Hommes & Domenico Massaro, . "Interest Rate Rules and Macroeconomic Stability under Heterogeneous Expectations," Tinbergen Institute Discussion Papers 09-040/1, Tinbergen Institute. [Downloadable!]
  14. Fabio Milani, 2009. "The Effect of Global Output on U.S. Inflation and Inflation Expectations: A Structural Estimation," Working Papers 080920, University of California-Irvine, Department of Economics. [Downloadable!]
  15. Pfajfar, D. & Zakelj, B., 2009. "Experimental Evidence on Inflation Expectation Formation," Discussion Paper 2009-07, Tilburg University, Center for Economic Research. [Downloadable!]
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