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Inflation Expectations and Stability in an Overlapping Generations Experiment with Money Creation

Author

Listed:
  • Peter Heemeijer
  • Cars Hommes
  • Joep Sonnemans
  • Jan Tuinstra

Abstract

We investigate how non-specialists form inflation expectations by running an experiment using a basic Overlapping Generations (OLG) model. The participants of the experiment are students of the University of Amsterdam, who predict inflation during 50 successive periods and are rewarded based on their accuracy. We include a central bank in the OLG model which increases the money supply at a constant rate. Participants are placed in separate OLG economies and are divided over two treatments: one with a "low" and one with a "high" money supply growth. We find that participants in the second treatment have substantially more difficulty in stabilizing inflation development by submitting accurate predictions than participants in the first treatment. However, when linear prediction rules are estimated on individual predictions, there is little difference between the two treatments. In both treatments, the most popular rules are Fundamentalist Expectations (predictions equal to the inflation sample mean) and Focal Expectations (predictions equal to a constant close to equilibrium). To verify whether participants adjust their prediction rules during the experiment, the estimated rules are checked for structural breaks. We find a surprisingly small number of structural breaks in both treatments.

Suggested Citation

  • Peter Heemeijer & Cars Hommes & Joep Sonnemans & Jan Tuinstra, 2010. "Inflation Expectations and Stability in an Overlapping Generations Experiment with Money Creation," DNB Working Papers 241, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:241
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Experimental economics; Expectations feedback; Inflation expectations; Price stability; Anchoring.;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • D - Microeconomics
    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G - Financial Economics
    • J - Labor and Demographic Economics

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