Expectations and Monetary Policy: Experimental Evidence
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.
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- Pfajfar, D. & Zakelj, B., 2011. "Uncertainty and Disagreement in Forecasting Inflation : Evidence from the Laboratory (Replaced by CentER DP 2012-072)," Discussion Paper 2011-053, Tilburg University, Center for Economic Research.