Experimental Evidence on the Persistence of Output and Inflation*

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  • *

     This article replaces an earlier version titled ‘Should Macroeconomists Consider Restricted Perceptions Equilibria? Evidence from the Experimental Laboratory’. The Carisal Foundation in Salerno, Italy and the Center for Financial Studies in Frankfurt, Germany provided financial support. Thanks go to seminar participants at University of Helsinki, Mannheim University, University of Frankfurt, University of Oregon and participants at the 2004 Konstanz Seminar on Monetary Theory and Policy, the 2004 SCE Meeting in Amsterdam, and the 2005 AEA Meeting in Philadelphia.

Abstract

This article presents experimental evidence from a monetary sticky price economy in which output and inflation depend on expected future inflation. Rational inflation expectations do not allow for persistent deviations of output and inflation following a monetary shock. In the experimental sessions, however, output and inflation display considerable persistence and regular cyclical patterns. This 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.

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