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Individual Expectations and Aggregate Macro Behavior

  • Assenza, T.

    ()

    (Catholic University of Milan)

  • Heemeijer, P.

    (De Nederlandsche Bank)

  • Hommes, C.H.

    ()

    (University of Amsterdam)

  • Massaro, D.

    ()

    (University of Amsterdam)

The way in which individual expectations shape aggregate macroeconomic variables is crucial for the transmission and effectiveness of monetary policy. We study the individual expectations formation process and the interaction with monetary policy, within a standard New Keynesian model, by means of laboratory experiments with human subjects. We find that a more aggressive monetary policy that sets the interest rate more than point for point in response to inflation stabilizes inflation in our experimental economies. We use a simple model of individual learning, with a performance-based evolutionary selection among heterogeneous forecasting heuristics, to explain coordination of individual expectations and aggregate macro behavior observed in the laboratory experiments. Three aggregate outcomes are observed: convergence to some equilibrium level, persistent oscillatory behavior and oscillatory convergence. A simple heterogeneous expectations switching model fits individual learning as well as aggregate outcomes and outperforms homogeneous expectations benchmarks.

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Paper provided by Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance in its series CeNDEF Working Papers with number 11-01.

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Date of creation: 2011
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Handle: RePEc:ams:ndfwpp:11-01
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Dept. of Economics and Econometrics, Universiteit van Amsterdam, Roetersstraat 11, NL - 1018 WB Amsterdam, The Netherlands

Phone: + 31 20 525 52 58
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Web page: http://www.fee.uva.nl/cendef/
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  1. Frank Smets & Raf Wouters, 2007. "Shocks and Frictions in US Business Cycles : a Bayesian DSGE Approach," Working Paper Research 109, National Bank of Belgium.
  2. Anufriev, M. & Hommes, C.H., 2009. "Evolutionary Selection of Individual Expectations and Aggregate Outcomes," CeNDEF Working Papers 09-09, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  3. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  4. 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.
  5. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," FRB Atlanta Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  6. Hommes, Cars, 2011. "The heterogeneous expectations hypothesis: Some evidence from the lab," Journal of Economic Dynamics and Control, Elsevier, vol. 35(1), pages 1-24, January.
  7. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  8. Carlos Capistrán & Allan Timmermann, 2008. "Disagreement and Biases in Inflation Expectations," CREATES Research Papers 2008-56, Department of Economics and Business Economics, Aarhus University.
  9. Jordi Galí, 2008. "Introduction to Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework
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  10. Marimon, R. & Sunder, S., 1993. "Expectations and Learning under Alternative Monetary Regimes: An Experimental Approach," Papers 189, Cambridge - Risk, Information & Quantity Signals.
  11. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report 217, Federal Reserve Bank of Minneapolis.
  12. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
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  14. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1036-1051, May.
  15. Damjan Pfajfar & Emiliano Santoro, 2010. "Heterogeneity, Learning and Information Stickiness in Inflation Expectations," Post-Print hal-00849412, HAL.
  16. Cars Hommes & Joep Sonnemans & Jan Tuinstra & Henk van de Velden, 2003. "Coordination of Expectations in Asset Pricing Experiments," Tinbergen Institute Discussion Papers 03-010/1, Tinbergen Institute.
  17. Christian Merkl, 2008. "Galí J: Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework," Journal of Economics, Springer, vol. 95(2), pages 179-181, November.
  18. Adriana Cornea & Cars Hommes & Domenico Massaro, 2013. "Behavioral Heterogeneity in U.S. Inflation Dynamics," Tinbergen Institute Discussion Papers 13-015/II, Tinbergen Institute.
  19. Pfajfar, D. & Zakelj, B., 2011. "Inflation Expectations and Monetary Policy Design : Evidence from the Laboratory (Replaces CentER DP 2009-007)," Discussion Paper 2011-091, Tilburg University, Center for Economic Research.
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  21. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  22. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
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