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Do expectations and decisions respond to monetary policy?

Luba Petersen (Department of Economics, Simon Fraser University, Vancouver, Canada)

Journal of Economic Studies

ISSN: 0144-3585

Article publication date: 9 November 2015

684

Abstract

Purpose

The purpose of this paper is to explore the ability of monetary policy to generate real effects in laboratory general equilibrium production economies.

Design/methodology/approach

To understand why monetary policy is not consistently effective at stabilizing economic activity, the author vary the types of agents interacting in the economy and consider treatments where subjects are playing the role of households (firms) in an economy where automated firms (households) are programmed to behave rationally.

Findings

While the majority of participants’ expectations respond to monetary policy in the direction intended, subjects do form expectations adaptively, relying heavily on past variables and forecasts in forming two-steps-ahead forecasts. Moreover, in the presence of counterparts that are boundedly rational, forecast accuracy worsens significantly. When interacting with automated households, updating firms’ prices respond modestly to monetary policy and significantly to anticipated marginal costs and future prices. The greatest deviations in behavior from theoretical predictions arise from human households (HH). Households persistent oversupply of labor and under-consumption is attributed to precautionary saving and debt aversion. The results provide evidence that the effects of monetary policy on decision making hinge on the distribution of indebtedness of households.

Originality/value

The author present causal evidence of the effects of potential bounded rationality on agents’ consumption and labor decisions.

Keywords

Acknowledgements

JEL Classification — C92, E2, E52, D50, D91

An earlier version of this paper was circulated under the title “Nonneturality of Money, Preferences, and Expectations in Laboratory New Keynesian Economies,” This research has been generously supported by the Sury Initiative for Global Finance and International Risk Management. Special thanks go to Jasmina Arifovic, Dan Friedman, Mariya Mileva, Ryan Oprea, Carl Walsh, Abel Winn and workshop and seminar participants at the 2011 SEA Meetings, 2012 LICTEM conference, University of New South Wales, University of Melbourne, University of Texas Dallas, and Santa Clara University, Copenhagen Business School, and Aarhus University for their invaluable insights and helpful comments.

Citation

Petersen, L. (2015), "Do expectations and decisions respond to monetary policy?", Journal of Economic Studies, Vol. 42 No. 6, pp. 972-1004. https://doi.org/10.1108/JES-08-2015-0149

Publisher

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Emerald Group Publishing Limited

Copyright © 2015, Emerald Group Publishing Limited

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