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Individual Expectations and Aggregate Macro Behavior

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Listed author(s):
  • Tiziana Assenza
  • Peter Heemeijer
  • Cars Hommes
  • Domenica Massaro

Abstract

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 behaviour 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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File URL: https://www.dnb.nl/en/binaries/working%20paper%20298_tcm47-254376.pdf
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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 298.

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Date of creation: May 2011
Handle: RePEc:dnb:dnbwpp:298
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Web page: http://www.dnb.nl/en/

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Keywords: Experiments; Monetary Policy; Expectations; Heterogeneity;

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Find related papers by JEL classification:
  • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
  • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  11. Cornea, A. & Hommes, C.H. & Massaro, D., 2012. "Behavioral Heterogeneity in U.S. Inflation Dynamics," CeNDEF Working Papers 12-03, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  12. 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.
  13. 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.
  14. Jordi Galí, 2008. "Introduction to Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework," Introductory Chapters,in: Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework Princeton University Press.
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