Monetary Policy Rules in a Non-Rational World: A Macroeconomic Experiment

Abstract

This paper introduces a new laboratory experiment based on the New-Keynesian macroeconomy in Woodford (2013). The purpose of the experiment is to study how monetary policy can influence individual expectations to achieve the stabilization of macroeconomic outcomes and to improve social welfare. The experimental design is closer to the microfoundations of the New-Keynesian model than previous experiments. The two main findings are: firstly, even abiding by the Taylor principle does not guarantee convergence to the steady state. Secondly, the welfare loss driven by expectation-driven volatility not necessarily found around the steady state can be reduced by adopting more aggressive anti-inflation Taylor rules. Thompson Sampling, a Bayesian learning approach originating from operations research, describes subjects' individual forecasting data well and can thus explain the patterns observed in the experiments.