UC Santa Cruz

This study explores how macroeconomic questions can be studied in laboratory settings. A novel experimental methodology is proposed and implemented to study how partial and general equilibrium economies respond to stochastic productivity and monetary shocks under various conditions. Following the DSGE approach, subjects interact over numerous periods to converge to a steady state, then are shocked with temporary or permanent shocks. Their responses to the shocks are compared with theoretical impulse responses. Findings indicate that subjects experience considerable difficulty converging to the efficient competitive equilibrium in economies where money is present. There is a high degree of heterogeneity in how individuals react to monetary shocks and form expectations. Elicited expectations are highly adaptive but are converging in the direction of rationality over extensive stationary repetition. We fail to find evidence in both partial and general equilibrium settings that subjects exhibit money illusion.