Working Papers

Monetary Policy under Behavioral Expectations: Theory and Experiment Link to paper Slides (PDF)
Cars Hommes, Domenico Massaro, and Matthias Weber. R&R at the European Economic Review.

In the media: Bloomberg.

Expectations play a crucial role in modern macroeconomic models. We replace the common assumption of rational expectations in a New Keynesian framework by the assumption that expectations are formed according to a heuristics switching model that has performed well in earlier work. We show how the economy behaves under these assumptions with a special focus on inflation volatility. Contrary to comparable models based on full rationality, 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 with a learning to forecast experiment. The experimental results support the behavioral model and the claim that reacting to the output gap in addition to inflation can indeed lower inflation volatility.


Experience Does not Eliminate Bubbles: Experimental Evidence Paper (PDF)
Anita Kopányi-Peuker and Matthias Weber

In the media: Investors Chronicle.

We study the role of experience in the formation of asset price bubbles. Therefore, we conduct two related experiments. One is a call market experiment in which participants trade assets with each other. The other is a learning-to-forecast experiment in which participants only forecast future prices, while the trade, which is based on these forecasts, is computerized. Each experiment comprises three treatments that vary the amount of information about the fundamental value that participants receive. Each market is repeated three times. In both experiments and in all treatments, we observe sizable bubbles. These bubbles do not disappear with experience. Our findings in the call market experiment stand in contrast to the literature. Our findings in the learning-to- forecast experiment are novel. Interestingly, the shape of the bubbles is different between the two experiments. We observe flat bubbles in the call market experiment and boom-and-bust cycles in the learning-to-forecast experiment.


The Behavioral Economics of Currency Unions: Economic Integration and Monetary Policy Link to paper
Akvile Bertasiute, Domenico Massaro, and Matthias Weber

In the media: VoxEU, HSG-#2minutes video.

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.


Network-Constrained Covariate Coefficient and Connection Sign Estimation Link to paper
Matthias Weber, Jonas Striaukas, Martin Schumacher, and Harald Binder. R&R at the International Journal of Forecasting.

Often, variables are linked to each other via a network. When such a network structure is known, this knowledge can be incorporated into regularized regression settings. In particular, an additional network penalty can be added on top of another penalty term, such as a Lasso penalty. However, when the type of interaction via the network is unknown (that is, whether connections are of an activating or a repressing type), the connection signs have to be estimated simultaneously with the covariate coefficients. This can be done with an algorithm iterating a connection sign estimation step and a covariate coefficient estimation step. We show detailed simulation results of such an algorithm. The algorithm performs well in a variety of settings. We also briefly describe the R-package that we developed for this purpose, which is publicly available.


Behavioral Optimal Taxation: The Case of Aspirations Link to paper
Matthias Weber

I provide a simple two-period model comparing lump-sum taxes with proportional labor taxes. The difference to the classical optimal taxation literature is that I introduce a behavioral twist according to which people’s aspirations change from one period to another as suggested by empirical evidence. It turns out that the policy implication from this model can differ significantly from the one assuming full rationality. In the behavioral model, a lump-sum tax is much less attractive. This paper does not aim at providing a full-fledged quantitative model, it should rather be seen as a cautionary tale about the robustness of classical optimal taxation results when deviating from full rationality.