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Expectations and Monetary Policy: Experimental Evidence

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  • Oleksiy Kryvtsov
  • Luba Petersen

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.

Suggested Citation

  • Oleksiy Kryvtsov & Luba Petersen, 2013. "Expectations and Monetary Policy: Experimental Evidence," Staff Working Papers 13-44, Bank of Canada.
  • Handle: RePEc:bca:bocawp:13-44
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    References listed on IDEAS

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    More about this item

    Keywords

    Business fluctuations and cycles; Monetary policy implementation; Transmission of monetary policy;
    All these keywords.

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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