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. We find that a more aggressive monetary policy that sets the interest rate more than point for point in response to inflation stabilizes inflation in our experimental economies. We use a simple model of individual learning, with a performance-based evolutionary selection among heterogeneous forecasting heuristics, to explain coordination of individual expectations and aggregate macro behavior observed in the laboratory experiments. Three aggregate outcomes are observed: convergence to some equilibrium level, persistent oscillatory behavior and oscillatory convergence. A simple heterogeneous expectations switching model fits individual learning as well as aggregate outcomes and outperforms homogeneous expectations benchmarks.

Price Stability and Volatility in Markets with Positive and Negative Expectations Feedback: An Experimental Investigation

The evolution of many economic variables is affected by expectations that economic agents have with respect to the future development of these variables. Here we show, by means of laboratory experiments, that market behavior depends to a large extent on how the realized market price responds to an increase in average price expectations. If it responds by decreasing, as in commodity markets, prices converge quickly to their equilibrium value, confirming the rational expectations hypothesis. If the realized price increases after an increase of average expectations, as is typical for financial markets, large fluctuations in realized prices are likely.

Forming price expectations in positive and negative feedback systems

We analyse the results of an experiment on expectation formation carried out last year (i.e., 2003) in the CREED laboratory in Amsterdam. The experiment involved 78 participants, who were asked to predict prices in artificial single-good economies, and were paid according to their accuracy in doing so. Thirteen markets, with six subjects each, were created, in two different treatments. The first treatment concerns a Cobweb-like commodity market with supply-driven expectations feedback. The second treatment concerns a speculative asset market with demanddriven expectations feedback. In the first treatment price fluctuations are relatively stable, quickly converging to the Rational Expectations fundamental value. In the second treatment prices do not converge quickly, but tend to display a slow oscillation around the fundamental price. An important factor in generating these differences is shown to be the strong coordination of price predictions among participants. This suggests a large degree of homogeneity in the expectation rules applied by the participants, which was confirmed by explicitly fitting the individual predictions to a linear adaptive autoregressive specification.

Managing self-organization of expectations through monetary policy: a macro experiment

The New Keynesian theory of inflation determination is tested in this paper by means of laboratory experiments. We find that the Taylor principle is a necessary condition to ensure convergence to the inflation target, but it is not sufficient. Using a behavioral model of expectation formation, we show how heterogeneous expectations tend to self-organize on different forecasting strategies depending on monetary policy. Finally, we link the central bank ability to control inflation to the impact that monetary policy has on the type of feedback {positive or negative{ between expectations and realizations of aggregate variables and in turn on the composition of subjects with respect to the type of forecasting rules they use

Introduction

This collected volume gives a concise account of the most relevant scientific results of the COST Action IS1104 "The EU in the new complex geography of economic systems: models, tools and policy evaluation", a four-year project supported by COST (European Cooperation in Science and Technology). It is divided into three parts reflecting the different perspectives under which complex spatial economic systems have been studied: (i) the Macro perspective looks at the interactions among international or regional trading partners; (ii) the Meso perspective considers the functioning of (financial, labour) markets as social network structures; and, finally, (iii) the Micro perspective focuses on the strategic choices of single firms and households. This Volume points also at open issues to be addressed in future research

A complex systems approach to constructing better models for managing financial markets and the economy

We outline a vision for an ambitious program to understand the economy and financial markets as a complex evolving system of coupled networks of interacting agents. This is a completely different vision from that currently used in most economic models. This view implies new challenges and opportunities for policy and managing economic crises. The dynamics of such models inherently involve sudden and sometimes dramatic changes of state. Further, the tools and approaches we use emphasize the analysis of crises rather than of calm periods. In this they respond directly to the calls of Governors Bernanke and Trichet for new approaches to macroeconomic modelling.The publication of this work was partially supported by the European Union’s Seventh Framework Programme (FP7/2007-2013) under grant agreement No. 284709, a Coordination and Support Action in the Information and Communication Technologies activity area (‘FuturICT’ FET Flagship Pilot Project). Doyne Farmer, Mauro Gallegati and Cars Hommes also acknowledge financial support from the EU-7th framework collaborative project “Complexity Research Initiative for Systemic InstabilitieS (CRISIS)”, grant No. 288501. Cars Hommes acknowledges financial support from the Netherlands Organization for Scientific Research (NWO), project “Understanding Financial Instability through Complex Systems”. None of the above are responsible for errors in this paper.Publicad