Monetary policy rules in a non-rational world: A macroeconomic experiment

• Published in: Journal of economic theory Vol. 197; p. 105203
• Main Author: Mauersberger, Felix
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.10.2021
• Subjects: Adaptive learning; Expectations; Interest rates; Laboratory experiment; New-Keynesian model; Expectations; Adaptive learning; E52; New-Keynesian model; E37; C91; Laboratory experiment; C92; Interest rates
• ISSN: 0022-0531; 1095-7235
• DOI: 10.1016/j.jet.2021.105203

This paper introduces a learning-to-forecast laboratory experiment based on a New-Keynesian macroeconomy that is particularly close to the model's microfoundations. In this setup, subjects forecast their individual optimal consumption and prices instead of aggregate outcomes. Due to different personal experiences, coordination of forecasting behavior does not occur naturally, and there is considerable randomness in subjects' responses. Thompson Sampling, a learning heuristic from operations research that links randomness to the Bayesian posterior uncertainty, describes subjects' individual forecasting data well, and explains the observed patterns in the experiments. The experimental results show that a particularly aggressive anti-inflation response by the central bank is needed to achieve coordination on rational expectations and macroeconomic stability. •A newly-designed laboratory experiment is used to investigate how strongly monetary policy authorities should respond to inflation.•Subjects' task is to forecast individual consumption and prices, which is in line with the microfoundations of New-Keynesian macroeconomics.•Individual forecasts exhibit much randomness, which is well explained by Thompson Sampling – a heuristic originating from operations research.•To stabilize the economy, the central bank's response to inflation must be very aggressive. Merely obeying the Taylor principle is insufficient.