Why do monetary policies matter? An experimental study of saving and inflation in an overlapping generations model
Michele Bernasconi and Oliver Kirchkamp
Abstract:We study experiments of an overlapping generations model where agents may transfer wealth from one period to the next (saving) and where government revenue is created through seigniorage. Inflation influences the amount of wealth an agent may wish to save in a given period. Inflation is determined by the monetary policy and by the amount of average saving within each period.
The framing of our experiment differs in several respects from the one that is used by Lim, Prescott, Sunder (1994), Marimon, Spear, Sunder (1993), Marimon, Sunder (1993,1994,1995). Some of the differences are:
- participants are not forced to save optimally and risk-neutrally, given their expectations;
- participants choose themselves whether they form expectations on inflation or on average savings;
- participants describe their expectations graphically;
- participants can test the implication of several different expectations before making a saving decision;
- the market is presented to subjects as a market operating in the EMU;
- monetary policies have labels and participants vote on monetary policies.
The above mentioned literature comes in particular to the conclusion that the choice of the monetary policy does not matter. Only the level of government deficit determines level and volatility of inflation.
Evidence from our experiments in Florence, Mannheim and Pavia challenges this point. We find that:
- in contrast to the literature, agents do not form first order adaptive expectations;
- while in Marimon and Sunder's exeriments subjects are forced to behave risk-neutrally, subjects `oversave' for precautionary reasons once they are allowed to.
- This `oversaving' or `precautionary saving' implies (in theory and
in the experiment) different levels of inflation and volatility for
different monetary policies (which are supposed to be equivalent in
the literature under optimal, risk-neutral behavior).
Therefore, in our experiment the so called Friedman conjecture holds, i.e. a money-growth style monetary rule turns out to be more stable
We relate our findings to the current research on the theories of coordination and equilibrium selection.
- Click here for a copy of the paper as a PDF file (750 kB bytes, 44 pages).
- Meanwhile the paper has been published as
- Oliver Kirchkamp, Michele Bernasconi (2000), “Why do monetary policies matter? An experimental study of saving and inflation in an overlapping generations model”, Journal of Monetary Economics, Vol. 46, pp. 315-343.
- We have implemented the experiment as a www-experiment. Here is a brief introduction to www-experiments
- Here are the instructions to the experiment in German as well as a translation of the instructions to English.
- What do you think about using this experiment as a part of your teaching? Please do not hesitate to contact us.
We thank Italian CNR and MURST and the Deutsche Forschungsgemeinschaft (SFB 504) for funding the project. The project started when both authors were Jean Monnet Fellows at the European University Institute (Florence) where some the experiments described in this paper were also conducted. We thank the Institute for its hospitality and for the assistance in running the experiments. We thank Ramon Marimon, Amy Verdun, Simon Hug for helpful discussions in designing the experiments.