Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence from the lab

Transcription

1 Monetary and Fiscal Policy Design at the Zero Lower Bound: Evidence from the lab Cars Hommes, Domenico Massaro & Isabelle Salle CeNDEF, University of Amsterdam EU FP7 MACFINROBODS Conference June 2015 Paris

2 Goals within MACFINROBODS WP1: Behaviour under uncertainty, heterogeneous agents and herding WP2: Expectations formation and belief heterogeneity Tasks and Objectives: run laboratory experiments with human subjects to test micro behavioral assumptions and aggregate macro behavior Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

3 Contents Outline 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

4 Motivation 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

5 Empirical evidence Motivation Liquidity trap in the Euro Area, US and UK Interest Rate Inflation EA EA 4 UK US 4 UK US Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

6 Empirical evidence Motivation Liquidity trap in the Euro Area, US and UK Interest Rate Inflation EA EA 4 UK US 4 UK US Fiscal stimulus at the ZLB? Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

7 Motivation Expectations and fiscal stimulus at the ZLB: theoretical contributions Under rational expectations/perfect foresight (Woodford 1999, Benhabib et al. 2001a,b): ZLB gives rise to a second, deflationary steady state, with the possibility of self-fulfilling decelerating inflation paths. A liquidity trap is a low but stable inflation state. Automatic fiscal stimulus rules out liquidity traps. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

8 Motivation Expectations and fiscal stimulus at the ZLB: theoretical contributions Under rational expectations/perfect foresight (Woodford 1999, Benhabib et al. 2001a,b): ZLB gives rise to a second, deflationary steady state, with the possibility of self-fulfilling decelerating inflation paths. A liquidity trap is a low but stable inflation state. Automatic fiscal stimulus rules out liquidity traps. Under adaptive learning (McCallum 2002, Evans et al. 2008, Benhabib et al. (2012)): The targeted steady state is not globally stable. Deflationary spiral is self-reinforcing. A preventive cut in interest rates is not enough, a fiscal switching rule restores global stability of the targeted state. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

9 Motivation Main objectives of this experimental paper 1 Characterizing liquidity traps using experimental evidence: Do liquidity traps arise in a learning-to-forecast experiment when expectations are formed by human subjects? Is a liquidity trap a low inflation steady state or deflationary spiral? 2 Assessing the empirical relevance of policy recommendations in a learning-to-forecast experiment: Is monetary policy enough to avoid/escape liquidity traps? (with a preventive cut in interest rate) Can a fiscal switching rule prevent a liquidity trap? What are the dynamics along the convergence path towards the targeted steady state? Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

10 Model 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

11 Model An expectation-feedback model: (c, π, R, g) Evans et al. (2008) Aggregate demand (IS curve): Aggregate supply/nkpc: c t = c ( π t = π c e t+1 + (,π e t+1 +,R t c t,π e t+1,g t ) ) Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

12 Model An expectation-feedback model: (c, π, R, g) Evans et al. (2008) Aggregate demand (IS curve): Aggregate supply/nkpc: Fiscal policy instrument : g t = ḡ c t = c ( π t = π c e t+1 + (,π e t+1 +,R t c t,π e t+1,g t Monetary policy rule with preventive cut interest rate: ( ) R π e t+1 /πt,ct+1 e /c if π t π + + R = ZLB if π t < π ) ) Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

13 Zero-lower bound and multiple steady states Multiple equilibria with aggressive monetary policy R R(π) π β 0.98 π L π * π~ Figure : Aggressive monetary policy rule (preventive cut to ZLB) and multiple steady states π

14 Model Policy Rules in Experiment M Monetary policy only Aggressive monetary policy: preventive cut at the ZLB if inflation falls below π 1.6%. Fiscal policy always remains fixed (g = ḡ). Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

15 Model Policy Rules in Experiment M Monetary policy only Aggressive monetary policy: preventive cut at the ZLB if inflation falls below π 1.6%. Fiscal policy always remains fixed (g = ḡ). F Fiscal Policy (together with monetary policy): Aggressive monetary policy: preventive cut at the ZLB if inflation falls below π 1.6%. "Fiscal switching rule": inflationary-threshold fiscal policy. If inflation falls below π despite the ZLB, g is increased so that inflation meets the threshold π. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

16 Model Global dynamics under adaptive learning Evans et al. (2008) : without fiscal policy c e Π Figure : Phase plot of the economy e under adaptive learning Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

17 Experimental design 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

18 Experimental design Learning to forecast experiment General context and information Two forecasts: net output and inflation. Interpretation: private forecasters and representative firm-household. Pay-off as a function of forecast errors; randomized between inflation and output. Qualitative information: positive/negative relationships between variables, time series, specific information on policies. A 2 2 treatment design: Monetary Policy with or without Fiscal Policy Expectations Pessimistic (P) or subject to negative Expectational Shocks (S) 7 experimental economies in each (28 in total). Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

19 Experimental design Policy treatments M Monetary policy only Aggressive monetary policy: preventive cut at the ZLB if inflation falls below π 1.6%. Fiscal policy always remains fixed (g = ḡ). F Fiscal Policy: Aggressive monetary policy: preventive cut at the ZLB if inflation falls below π 1.6%. "Fiscal switching rule": inflationary-threshold fiscal policy. If inflation falls below π despite the ZLB, g is increased so that inflation meets the threshold π. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

20 Experimental design Expectations treatments P Initial severe pessimism: [ 8,8]% (5%) and [50,80] (74). Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

21 Experimental design Expectations treatments P Initial severe pessimism: [ 8,8]% (5%) and [50,80] (74). S Initial mild pessimism + news shocks: [ 5,8]% (5%) and [60,80] (74). NEWS Experts predict a decrease in inflation and net output Figure : News shocks at periods 8,9 and 10. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

22 Learning to forecast experiment Timing of events (under aggressive monetary policy)... Subjects are Compute asked to the average forecast forecasts c t+1 and π t+1 (c e t+1, πt+1) e t t The CB sets R t based on π e t+1 (and c e t+1 ) t Euler eq. gives c t based on c e t+1, πe t+1, Rt t Fiscal policy g t = ḡ t Phillips curve if π t < π Subjects gives π t The CB sets observe based on πt+1, e R t = ZLB c t, π t, R t, g t c t, g t t + 5 and c t, π t are 8 recomputed t Subjects are asked to forecast c t+2 and π t+2 t t + 6 8

23 Learning to forecast experiment Timing of events (under policy mix)... Subjects are asked to forecast Compute the average forecasts The CB sets R t based on πt+1 e Euler eq. gives c t based on c t+1 and π t+1 t (c e t+1, πt+1) e t (and c e t+1 ) t c e t+1, πe t+1, Rt t Fiscal policy g t = ḡ t Phillips curve if π t < π Fiscal policy Subjects gives π t The CB sets if π based on t π observe πt+1, e R t = ZLB c c t, g t, π t, R t, g t t g t = ḡ t + 5 and c t, π t are 9 recomputed if π t + 8 t < π 9 Subjects are asked to forecast c t+2 and π t+2 t t sets g t so that π t = π t + 7 9

24 Experimental results 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

25 Overview 2x2 Treatments: Policy versus Expectations Severe Pessimism Monetary policy only 5 deflationary spirals (initial pessimism) 2 convergences to steady state with ZLB additional Fiscal Policy 1 convergence with standard policy 6 convergences with policy mix: 2 oscillatory convergence paths, 4 liquidity traps Mild pessimism + news shock 4 deflationary spirals after news 3 convergences to steady state (1 with ZLB) 1 convergences with standard policy 6 convergences with policy mix: 3 oscillatory convergence paths, 3 liquidity traps

26 Treatment MP: Monetary Policy and Pessimistic Expectations 2 convergences and 5 deflationary spirals 1.1 Inflation Treatment MP 0.8 Net Output Treatment MP Inflation Net Output Period Period

27 80 Phase plot of the experimental economy L T net output stable unstable 50-8% π T +8% π L inflation

28 80 Initial expectations in Tr. MP/severe pessimism (b) L T net output stable unstable 50-8% π T +8% π L inflation

29 80 Fall in a liquidity trap in Tr. MP/severe pessimism (b) L T net output stable unstable 50-8% π T +8% π L inflation

30 80 Convergence in Tr. MP/severe pessimism (b) L T net output stable unstable 50-8% π T +8% π L inflation

31 Treatment MS: Monetary Policy and Mild Pessimistic Expectations with News Shocks 3 convergences and 4 deflationary spirals 1.1 Inflation Treatment MS 0.8 Net Output Treatment MS Inflation Net Output Period Period

32 80 Initial expectations in Tr. MP/mild pessimism (a) L T net output stable unstable 50-8% π T +8% π L inflation

33 Expectations before the news in Tr. MP/mild pessimism (a) 80 L T net output stable unstable 50-8% π T +8% π L inflation

34 80 Expectations after the news in Tr. MP/mild pessimism (a) L T net output stable unstable 50-8% π T +8% π L inflation

35 80 Fall in a liquidity trap by expectational shock L T net output stable unstable 50-8% π T +8% π L inflation

36 80 Fall in a liquidity trap by expectational shock L T net output stable unstable 50-8% π T +8% π L inflation

37 80 Fall in a liquidity trap by expectational shock L T net output stable unstable 50-8% π T +8% π L inflation

38 Treatment MP: Fiscal Policy and Pessimistic Expectations 7 convergences, 6 with fiscal switching rule, no deflationary spirals 1.1 Inflation Treatment FP 0.8 Net Output Treatment FP Inflation Net Output Period Period

39 80 Effect of policy mix in Tr. MFP/severe pessimism (b) L T net output stable unstable 50-8% π T +8% π L inflation

40 80 Effect of policy mix in Tr. MFP/severe pessimism (b) L T net output stable unstable 50-8% π T +8% π L inflation

41 Treatment MP: Fiscal Policy and Mild Pessimistic Expectations with News Shocks 7 convergences, 6 with fiscal switching rule, no deflationary spirals 1.1 Inflation Treatment FS 0.8 Net Output Treatment FS Inflation Net Output Period Period

42 Effect of policy mix after the news in Tr. MFP/mild pessimism (a) 80 L T net output stable unstable 50-8% π T +8% π L inflation

43 Effect of policy mix after the news in Tr. MFP/mild pessimism (a) 80 L T net output stable unstable 50-8% π T +8% π L inflation

44 Experimental results Estimates of the fiscal multiplier at ZLB in Lab News Shocks in Periods 8-10 Estimates based on counter-factual analysis (MS vs. FS): fiscal multiplier µ t = y F t+1 y M t+1 g F t ḡ Government Expenditures Net Output 1.50 Fiscal Multiplier 0.30 FS MS FS MS Period Period Period Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

45 Experimental results Estimates of the fiscal multiplier at ZLB in Lab after initial Pessimistic Expectations periods 1-4 Estimates based on counter-factual analysis (MS vs. FS): fiscal multiplier µ t = y F t+1 y M t+1 g F t ḡ Government Expenditures 0.75 Net Output 3.0 Fiscal Multiplier FS MS Period FP MP Period Period Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

46 Experimental results Policy Debate: should FED raise target inflation rate to avoid liquidity traps? increasing target inflation, means increasing ZLB nominal rate R; this leads to an upward shift of the stable manifold of the low inflation steady state L this may more easily lead to a deflationary spiral L L' T 0.70 A c e Π e Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

47 Conclusions 1 Motivation 2 Model 3 Experimental design 4 Experimental results 5 Conclusions Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

48 Conclusions Sum-up 1 Deflationary spirals can arise as a result of pessimistic expectations even with an aggressive monetary policy using a preventive cut in the interest rate. 2 A fiscal policy switching rule prevents deflationary spirals. 3 The fiscal multiplier raises above one through theexpectations channel. 4 Raising target inflation makes liquidity traps more likely. Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

49 Conclusions Behavioural Macro Experiments 1 Expectations are the most important transmission channel of macro policies Learning to Forecast Experiments empirical validation of policy recommendations that rely on specific expectation formation mechanisms e.g. what to target? forward guidance, fiscal policy taking into account sovereign risk channel. 2 Learning to Optimize Experiments: expectations are only one part of the story. 3 Large scale-experiments Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45

50 Conclusions Thank you for your attention Hommes, Massaro & Salle (UvA) Liquidity Trap in the Lab Paris, June / 45