Domenico Massaro

Individual Expectations and Aggregate Macro Behavior

The way in which individual expectations shape aggregate macroeconomic variables is crucial for the transmission and effectiveness of monetary policy. We study the individual expectations formation process and the interaction with monetary policy, within a standard New Keynesian model, by means of laboratory experiments with human subjects. Three aggregate outcomes are observed: convergence to some equilibrium level, persistent oscillatory behavior and oscillatory convergence. We fit a heterogeneous expectations model with a performance-based evolutionary selection among heterogeneous forecasting heuristics to the experimental data. A simple heterogeneous expectations switching model fits individual learning as well as aggregate macro behavior and outperforms homogeneous expectations benchmarks. Moreover, in accordance to theoretical results in the literature on monetary policy, we find that an interest rate rule that reacts more than point for point to inflation has some stabilizing effects on inflation in our experimental economies, although convergence can be slow in presence of evolutionary learning.

Behavioral heterogeneity in U.S. inflation dynamics

ABSTRACT In this article we develop and estimate a behavioral model of inflation dynamics with heterogeneous firms. In our stylized framework there are two groups of price setters, fundamentalists and random walk believers. Fundamentalists are forward-looking in the sense that they believe in a present-value relationship between inflation and real marginal costs, while random walk believers are backward-looking, using the simplest rule of thumb, naive expectations, to forecast inflation. Agents are allowed to switch between these different forecasting strategies conditional on their recent relative forecasting performance. We estimate the switching model using aggregate and survey data. Our results support behavioral heterogeneity and the significance of evolutionary learning mechanism. We show that there is substantial time variation in the weights of forward-looking and backward-looking behavior. Although on average the majority of firms use the simple backward-looking rule, the market has phases in which it is dominated by either the fundamentalists or the random walk believers.

Experiments on expectations in macroeconomics and finance

Expectations play a crucial role in nance, macroeconomics, monetary economics and fiscal policy. In the last decade a rapidly increasing number of laboratory experiments have been performed to study individual expectation formation, the interactions of individual forecasting rules and the aggregate macro behavior they co-create. The aim of this chapter is to provide a comprehensive literature survey on laboratory experiments on expectations in macroeconomics and finance. In particular, we discuss the extent to which expectations are rational or may be described by simple forecasting heuristics, at the individual as well as the aggregate level.

Monetary Policy Under Behavioral Expectations: Theory and Experiment

Expectations play a crucial role in modern macroeconomic models. We consider a New Keynesian framework under a behavioral model of expectation formation and under rational expectations. Contrary to the rational model, the behavioral model predicts that inflation volatility can be lowered if the central bank reacts to the output gap in addition to inflation. We test the opposing theoretical predictions in a learning-to-forecast experiment. In line with the behavioral model, the results support the claim that output stabilization can lead to less volatile inflation.

Genetic Algorithm Learning in a New Keynesian Macroeconomic Setup

In order to understand heterogeneous behavior amongst agents, empirical data from Learning-to-Forecast (LtF) experiments can be used to construct learning models. This paper follows up on Assenza et al. (2013) by using a Genetic Algorithms (GA) model to replicate the results from their LtF experiment. In this GA model, individuals optimize an adaptive, a trend following and an anchor coefficient in a population of general prediction heuristics. We replicate experimental treatments in a New-Keynesian environment with increasing complexity and use Monte Carlo simulations to investigate how well the model explains the experimental data. We find that the evolutionary learning model is able to replicate the three different types of behavior, i.e. convergence to steady state, stable oscillations and dampened oscillations in the treatments using one GA model. Heterogeneous behavior can thus be explained by an adaptive, anchor and trend extrapolating component and the GA model can be used to explain heterogeneous behavior in LtF experiments with different types of complexity.

The Behavioral Economics of Currency Unions: Economic Integration and Monetary Policy

Currency unions are often modeled as homogeneous economies, although they are fundamentally different. The expectations that impact macroeconomic behavior in any given country are not the expectations of variables at the currency-union level but at the country level. We model these expectations with a behavioral reinforcement learning model. In our model, economic integration is of particular importance in determining whether economic behavior in a currency union is stable. Monetary policy alone is insufficient to guarantee stable economic behavior, as the central bank cannot conduct different monetary policies in different countries. These results are easily overlooked when modeling expectations as rational. JEL classification: E03, F45, E52, D84

Experiments in Macroeconomics

Expectations play a crucial role in nance, macroeconomics, monetary economics and fiscal policy. In the last decade a rapidly increasing number of laboratory experiments have been performed to study individual expectation formation, the interactions of individual forecasting rules and the aggregate macro behavior they co-create. The aim of this chapter is to provide a comprehensive literature survey on laboratory experiments on expectations in macroeconomics and finance. In particular, we discuss the extent to which expectations are rational or may be described by simple forecasting heuristics, at the individual as well as the aggregate level.

Research in Experimental Economics

Expectations play a crucial role in nance, macroeconomics, monetary economics and fiscal policy. In the last decade a rapidly increasing number of laboratory experiments have been performed to study individual expectation formation, the interactions of individual forecasting rules and the aggregate macro behavior they co-create. The aim of this chapter is to provide a comprehensive literature survey on laboratory experiments on expectations in macroeconomics and finance. In particular, we discuss the extent to which expectations are rational or may be described by simple forecasting heuristics, at the individual as well as the aggregate level.