Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence From the Lab

Hommes, Cars; Massaro, Domenico; Salle, Isabelle

doi:10.1111/ecin.12741

Cited by 33 publications

(23 citation statements)

References 79 publications

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“…By providing the theoretical conditions under which monetary policy effectively turns a context of strategic complements into a context of strategic substitutes, our results complement the conclusion reached by Hommes (2018, p. 84), according to which " [t]he laboratory macro experiments also suggest an immediate way to stabilize the economy: policy can stabilize the economy by adding negative feedback to the system, or equivalently, by weakening the positive feedback." Our results can also rationalize why monetary policy is found to be effective in a variety of monetary policy experiments, like Assenza et al (2013), Bao and Zong (2019), Pfajfar and Žakelj (2018), Hennequin and Hommes (2019), and Hommes et al (2019).…”

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confidence: 72%

Monetary policy obeying the Taylor principle turns prices into strategic substitutes

Cornand

Heinemann

2022

Journal of Economic Behavior & Organization

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Monetary policy affects the degree of strategic complementarity in firms' pricing decisions if it responds to the aggregate price level. In normal times, when monopolistic competitive firms increase their prices, the central bank raises interest rates, which lowers demand and creates an incentive for firms to reduce their prices. Thereby, monetary policy reduces the degree of strategic complementarities among firms' pricing decisions and even turns prices into strategic substitutes if the effect of interest rates on demand is sufficiently strong. We show that this condition holds when monetary policy follows the Taylor principle. By contrast, if the equilibrium is indeterminate, because monetary policy violates the Taylor principle, or in a liquidity trap where monetary policy is restricted by the zero lower bound, pricing decisions are strategic complements. We discuss the consequences for dynamic adjustment processes after shocks and some policy implications.

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supporting

confidence: 72%

Monetary policy obeying the Taylor principle turns prices into strategic substitutes

Cornand

Heinemann

2022

Journal of Economic Behavior & Organization

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“…This result is confirmed by Hommes et al (2015), who conduct a laboratory experiment, where, rather than making any assumptions on agent's expectations, they let expectations be formed by human subjects in the laboratory. Without fiscal intervention, deflationary spirals regularly occur in their experiment.…”

Section: Introductionmentioning

confidence: 64%

Fiscal stimulus in expectations-driven liquidity traps

Lustenhouwer

2020

Journal of Economic Behavior & Organization

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I study liquidity traps in a model were agents have heterogeneous expectations and finite planning horizons. Backward-looking agents base their expectations on past observations, while forward-looking agents have fully rational expectations. Liquidity traps that are fully or partly driven by expectations can arise due to pessimism of backward-looking agents. Only when planning horizons are finite, these liquidity traps can be of longer duration without ending up in a deflationary spiral. I further find that fiscal stimulus in the form of an increase in government spending or a cut in consumption taxes can be very effective in mitigating the liquidity trap. A feedback mechanism of heterogeneous expectations causes fiscal multipliers to be the largest when the majority of agents is backward-looking but there also is a considerable fraction of agents that are forward-looking. Labor tax cuts are always deflationary and are not an effective tool in a liquidity trap.

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“…Ahrens 2 The LtFE methodology originates with Marimon and Sunder (1993), who study price forecasting in an overlapping-generations experimental economy. Experiments studying inflation and output gap expectations in New Keynesian reduced form economies have been developed to study expectation formation and equilibria selection (Adam 2007); the effects of different monetary policy rules on expectation formation Zakelj 2014, 2016;Assenza et al 2019;Hommes et al 2019a); expectation formation at the zero lower bound (Arifovic and Petersen 2017;Hommes et al 2019b). Backward-looking, inattentive forecasting behavior frequently observed in laboratory experiments is also widely found in household and professional forecasts (Malmendier and Arifovic and Petersen (2017) to study the effects of one-period ahead inflation projections in the presence of both demand and supply shock in the normal times or at the zero lower bound.…”

Section: Introductionmentioning

confidence: 99%

Coordinating expectations through central bank projections

Mokhtarzadeh

Petersen

2020

Exp Econ

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Central banks are increasingly communicating their economic outlook in an effort to manage the public and financial market participants’ expectations. We provide original causal evidence that the information communicated and the assumptions underlying a central bank’s projection can matter for expectation formation and aggregate stability. Using a between-subject design, we systematically vary the central bank’s projected forecasts in an experimental macroeconomy where subjects are incentivized to forecast the output gap and inflation. Without projections, subjects exhibit a wide range of heuristics, with the modal heuristic involving a significant backward-looking component. Ex-Ante Rational dual projections of the output gap and inflation significantly reduce the number of subjects’ using backward-looking heuristics and nudge expectations in the direction of the rational expectations equilibrium. Ex-Ante Rational interest rate projections are cognitively challenging to employ and have limited effects on the distribution of heuristics. Adaptive dual projections generate unintended inflation volatility by inducing boundedly-rational forecasters to employ the projection and model-consistent forecasters to utilize the projection as a proxy for aggregate expectations. All projections reduce output gap disagreement but increase inflation disagreement. Central bank credibility is significantly diminished when the central bank makes larger forecast errors when communicating a relatively more complex projection. Our findings suggest that inflation-targeting central banks should strategically ignore agents’ irrationalities when constructing their projections and communicate easy-to-process information.

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Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence From the Lab

Cited by 33 publications

References 79 publications

Monetary policy obeying the Taylor principle turns prices into strategic substitutes

Monetary policy obeying the Taylor principle turns prices into strategic substitutes

Fiscal stimulus in expectations-driven liquidity traps

Coordinating expectations through central bank projections

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