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Coordinating expectations through central bank projections

Author

Listed:
  • Fatemeh Mokhtarzadeh

    (University of Victoria)

  • Luba Petersen

    (Simon Fraser University)

Abstract

Central banks are increasingly communicating their economic outlook in an effort to manage the public and financial market participants’ expectations. We provide original causal evidence that the information communicated and the assumptions underlying a central bank’s projection can matter for expectation formation and aggregate stability. Using a between-subject design, we systematically vary the central bank’s projected forecasts in an experimental macroeconomy where subjects are incentivized to forecast the output gap and inflation. Without projections, subjects exhibit a wide range of heuristics, with the modal heuristic involving a significant backward-looking component. Ex-Ante Rational dual projections of the output gap and inflation significantly reduce the number of subjects’ using backward-looking heuristics and nudge expectations in the direction of the rational expectations equilibrium. Ex-Ante Rational interest rate projections are cognitively challenging to employ and have limited effects on the distribution of heuristics. Adaptive dual projections generate unintended inflation volatility by inducing boundedly-rational forecasters to employ the projection and model-consistent forecasters to utilize the projection as a proxy for aggregate expectations. All projections reduce output gap disagreement but increase inflation disagreement. Central bank credibility is significantly diminished when the central bank makes larger forecast errors when communicating a relatively more complex projection. Our findings suggest that inflation-targeting central banks should strategically ignore agents’ irrationalities when constructing their projections and communicate easy-to-process information.

Suggested Citation

  • Fatemeh Mokhtarzadeh & Luba Petersen, 2021. "Coordinating expectations through central bank projections," Experimental Economics, Springer;Economic Science Association, vol. 24(3), pages 883-918, September.
  • Handle: RePEc:kap:expeco:v:24:y:2021:i:3:d:10.1007_s10683-020-09684-6
    DOI: 10.1007/s10683-020-09684-6
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    More about this item

    Keywords

    Expectations; Monetary policy; Projections; Communication; Credibility; Laboratory experiment; Experimental macroeconomics;
    All these keywords.

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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