Working Paper: CEPR ID: DP4885
Authors: Klaus Adam
Abstract: This paper presents experimental evidence from a monetary sticky price economy in which output and inflation depend on expected future inflation. With rational inflation expectations, the economy does not generate persistent deviations of output and inflation in response to a monetary shock. In the experimental sessions, however, output and inflation display considerable persistence and regular cyclical patterns. Such behaviour emerges because subjects? inflation expectations fail to be captured by rational expectations functions. Instead, a Restricted Perceptions Equilibrium (RPE), which assumes that agents use optimal but ?simple? forecast functions, describes subjects? inflation expectations surprisingly well and explains the observed behaviour of output and inflation.
Keywords: experiments; output and inflation dynamics; rational expectations; restricted perceptions equilibrium
JEL Codes: C91; E32; E37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Inflation expectations (E31) | Output persistence (C41) |
| Inflation expectations (E31) | Inflation persistence (E31) |
| Restricted perceptions equilibrium (RPE) (D50) | Output persistence (C41) |
| Restricted perceptions equilibrium (RPE) (D50) | Inflation persistence (E31) |
| Deviations from rational expectations (D84) | Output persistence (C41) |
| Deviations from rational expectations (D84) | Inflation persistence (E31) |
| Forecasting technology (C53) | Inflation expectations (E31) |
| Forecasting technology (C53) | Output persistence (C41) |
| Forecasting technology (C53) | Inflation persistence (E31) |