The distortionary effect of monetary policy: credit expansion vs. lump-sum transfers in the lab
-
Romain Baeriswyl
and
Camille Cornand
Abstract
In an experimental monetary general equilibrium economy, we assess two processes of monetary injection: credit expansion vs. lump-sum monetary transfers. In theory, both processes are neutral and exert no real effect on allocation. In the experiment, however, credit expansion leads to substantial distortions of real allocation and relative prices, and exerts a redistributive effect across subjects. By contrast, an increase in money through lump-sum transfers does not distort real allocation.
Acknowledgement
The views expressed in this paper are those of the authors and do not necessarily reflect those of the Swiss National Bank. We are grateful to Quentin Thévenet for designing the computer software and providing excellent assistance. We would like to thank Katrin Assenmacher, Peter Bossaerts, John Duffy, Frank Heinemann, Rosemarie Nagel, Luba Petersen, an anonymous referee, and the editor, Tiago Cavalcanti, for helpful discussions and comments, as well as participants at the conference on “Monetary policy challenges from a small country perspective” at the National Bank of Slovakia, at the 7th annual conference of the Society for Experimental Finance in Mannheim, and at the “Eighth Workshop on Theoretical and Experimental Macroeconomics” in Stony Brook. Finally, we are grateful to the ANR-DFG joint grant for financial support (ANR-12-FRAL-0013-01). This research was performed within the framework of the LABEX CORTEX (ANR-11-LABX-0042) of Université de Lyon, within the program “Investissements d’Avenir” (ANR-11-IDEX-007) operated by the French National Research Agency (ANR).
Appendix
A Realised prices and production
Realised interest rate r and price of goods 1 p1 and 2 p2. B: baseline, C: credit expansion, L: lump-sum transfers.
| r | p1 | p2 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| B | C | L | B | C | L | B | C | L | |
| Group 1 | 0.94 | 0.74 | 0.93 | 6.06 | 8.22 | 6.69 | 8.01 | 10.06 | 12.02 |
| Group 2 | 0.96 | 0.74 | 1.10 | 5.40 | 8.39 | 6.22 | 7.94 | 9.63 | 13.14 |
| Group 3 | 0.89 | 0.78 | 0.95 | 5.42 | 8.36 | 6.74 | 8.19 | 10.07 | 11.75 |
| Group 4 | 0.98 | 0.88 | 0.99 | 4.98 | 7.67 | 6.65 | 8.75 | 10.76 | 12.03 |
| Group 5 | 0.91 | 0.78 | 0.96 | 5.07 | 7.59 | 6.44 | 8.57 | 10.70 | 12.03 |
| Group 6 | 0.89 | 0.75 | 0.98 | 5.15 | 7.51 | 6.48 | 8.41 | 10.76 | 12.19 |
| Group 7 | 0.91 | 0.78 | 0.86 | 5.10 | 7.25 | 6.59 | 8.87 | 10.96 | 12.12 |
| Group 8 | 1.06 | 0.81 | 0.89 | 4.82 | 7.45 | 6.45 | 9.49 | 11.18 | 12.42 |
| Group 9 | 1.09 | 0.86 | 0.96 | 4.61 | 8.47 | 7.14 | 9.14 | 9.65 | 11.04 |
| Group 10 | 0.92 | 0.81 | 0.88 | 4.45 | 6.69 | 6.09 | 9.40 | 12.00 | 12.72 |
| Group 11 | 0.90 | 0.83 | 0.99 | 4.74 | 7.48 | 6.42 | 9.03 | 10.85 | 12.58 |
| Group 12 | 0.89 | 0.87 | 0.93 | 4.72 | 7.06 | 6.66 | 9.05 | 11.27 | 11.62 |
| Average | 0.94 | 0.80 | 0.95 | 5.04 | 7.68 | 6.55 | 8.74 | 10.66 | 12.14 |
| Deviation | 0.04 | −0.10 | 0.05 | 0.54 | 1.38 | 0.25 | 0.03 | −1.53 | −0.05 |
Realised production of goods 1 gi,1 and 2 gi,2. B: baseline, C: credit expansion, L: lump-sum transfers.
| gi,1 | gi,2 | |||||
|---|---|---|---|---|---|---|
| B | C | L | B | C | L | |
| Group 1 | 9.55 | 9.37 | 10.96 | 6.19 | 6.48 | 5.67 |
| Group 2 | 10.70 | 9.75 | 12.63 | 5.83 | 6.23 | 4.79 |
| Group 3 | 9.55 | 8.86 | 11.31 | 6.39 | 6.80 | 5.58 |
| Group 4 | 10.54 | 9.22 | 10.84 | 5.84 | 6.54 | 5.78 |
| Group 5 | 10.40 | 9.19 | 10.57 | 5.96 | 6.65 | 5.99 |
| Group 6 | 10.49 | 9.48 | 10.67 | 5.91 | 6.48 | 5.94 |
| Group 7 | 10.15 | 9.88 | 11.01 | 6.04 | 6.31 | 5.65 |
| Group 8 | 10.29 | 9.45 | 10.27 | 5.96 | 6.51 | 6.12 |
| Group 9 | 10.95 | 8.97 | 10.19 | 5.68 | 6.79 | 6.16 |
| Group 10 | 10.47 | 9.29 | 10.40 | 6.01 | 6.61 | 6.07 |
| Group 11 | 10.92 | 9.34 | 11.07 | 5.68 | 6.54 | 5.66 |
| Group 12 | 10.00 | 9.81 | 10.78 | 6.15 | 6.36 | 5.87 |
| Average | 10.33 | 9.39 | 10.89 | 5.97 | 6.52 | 5.77 |
| Deviation | −0.78 | −1.72 | −0.22 | 0.23 | 0.78 | 0.03 |
Average realised prices.
B Convergence pattern
Convergence pattern of decision 3. p-values in parentheses.
| α = 0.25 | α = 0.35 | α = 0.45 | α = 0.55 | α = 0.65 | α = 0.75 | |
|---|---|---|---|---|---|---|
| Z1 | 0.51 | 0.49 | 0.52 | 0.49 | 0.53 | 0.46 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| Z2 | 0.32 | 0.40 | 0.47 | 0.50 | 0.61 | 0.70 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| R2 | 0.31 | 0.12 | 0.05 | 0.00 | 0.07 | 0.44 |
Convergence pattern of production of goods 1 and 2. p-values in parentheses.
| gi,1 | gi,2 | |||||
|---|---|---|---|---|---|---|
| B | C | L | B | C | L | |
| Z1 | 10.56 | 7.33 | 11.87 | 5.76 | 7.49 | 5.21 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| Z2 | 10.27 | 9.97 | 10.61 | 6.03 | 6.25 | 5.93 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| R2 | 0.02 | 0.89 | 0.75 | 0.06 | 0.88 | 0.82 |
| Equilibrium | 11.11 | 11.11 | 11.11 | 5.74 | 5.74 | 5.74 |
Convergence pattern of interest rate and good prices 1 and 2. p-values in parentheses.
| r | p1 | p2 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| B | C | L | B | C | L | B | C | L | |
| Z1 | 0.94 | 0.68 | 0.98 | 5.31 | 10.07 | 6.24 | 9.06 | 8.86 | 13.24 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| Z2 | 0.95 | 0.84 | 0.94 | 4.97 | 6.99 | 6.64 | 8.65 | 11.17 | 11.83 |
| (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | (0.00) | |
| R2 | 0.00 | 0.48 | 0.07 | 0.03 | 0.91 | 0.16 | 0.03 | 0.82 | 0.44 |
| Equilibrium | 0.90 | 0.90 | 0.90 | 4.50 | 6.30 | 6.30 | 8.71 | 12.19 | 12.19 |
C Decisions across utility preference
Distribution of decisions across utility preference αi.
D Instructions
Instructions to participants varied according to the treatments. We present the instructions for a treatment with order of stages: B, C, and L. For the other treatment (B, L, and C), instructions were adapted accordingly and are available upon request.[12]
Instructions
General description of the experiment
Thank you for participating in an experiment in which you can earn money. These earnings will be paid to you in cash at the end of the experiment.
We ask you not to communicate from now on. If you have a question, then raise your hand and the instructor will come to you.
You are a group of 18 persons in total participating in this experiment and you are allocated into three groups of six persons. These three groups are totally independent and do not interact one with another during the whole length of the experiment. Each participant interacts only with other participants in his group and not with the participants of the other groups.
The current instructions describe the rules of the game for a group of six participants.
The rules are the same for all the participants. The experiment consists of three stages, each including 15 periods. At each of the 45 periods, you are asked to make three decisions. Your payoff depends on the decisions you make all along the experiment. After each period, you are told about the outcome and your gains, which will allow you to adjust your decisions at each new period.
General information
Each participant is an entrepreneur who produces and consumes two types of goods, good 1 and good 2. All transactions are made in ECU (Experimental Currency Unit) at market price. You have to decide how much to invest in the production of good 1 and good 2, and how much to consume of good 1 and good 2. Your production of good 1 and good 2 is sold at market price and it earns you an income that allows you to buy at market price your consumption of good 1 and good 2. The value of your consumption corresponds to the value of your production. However, the proportion of good 1 and good 2 that you consume does not necessarily correspond to the proportion of good 1 and good 2 that you produce. You have to optimise your production and your consumption in order to maximise your payoffs in ECUs.
At each period, you are endowed with an initial amount of ECUs. You have to make three decisions. The ECUs you are initially endowed with can either be invested in the production of good 1, or be lent on the credit market. There is no default risk on the credit market. The choice to invest in the production of good 1 and to lend on the credit market correspond to decision 1. The ECUs that you invest in the production of good 2 have to be borrowed on the credit market. The amount that you which to borrow and invest in the production of good 2 corresponds to decision 2. The amount in ECUs that you lend on the credit market (decision 1) does not necessarily correspond to the amount that you borrow for the production of good 2 (decision 2). Finally, you allocate the product of your production to the consumption of good 1 and good 2. The allocation between goods 1 and 2 constitutes decision 3.
At each period, each participant makes his/her three decisions individually though at the same time of the other participants of his/her group. When all the participants of the same group have made their three decisions, you are told about the outcome of the period and the market prices.
Production (supply) and consumption (demand) of goods 1 and 2 determine prices of goods 1 and 2. The loans and borrowings on the credit market determine the interest rate. Prices as well as the market interest rate determine the payoff (in ECUs) that each participant gets owing to his/her production as well as the payoff associated with consumption of goods 1 and 2.
The three decisions that you have to make at each of the 45 periods are now described more precisely.
Decision 1: production of good 1, loan on the credit market
To make decision 1, you have to split your initial ECUs into the amount that you choose to invest in the production of good 1 and the amount that you lend on the credit market. Concretely, you have to enter into the computer the amount of your initial ECUs that you want to lend on the credit market. The rest (of the initial amount of ECUs) corresponds to the amount that you invest in the production of good 1. For example, if you hold 100 initial ECUs and that you lend 30.0 ECUs on the credit market, your investment in the production of good 1 will be 70.0.
The amount that you invest in the production of good 1 earns you the product of the sale of good 1 (quantity produced × price of good 1). The amount that you lend on the credit market earns you an interest (amount lent × interest rate).
You will neither know the price of good 1, nor the interest rate when you make your decision because they result from the decisions of all participants. However, from the second period on, you will know the price and the interest rate of the preceding period, which will allow you to adjust your decision at each new period.
During the first period, you have to make your decision with no information on price and interest rate. During the next periods, you have to maximise your payoffs by comparing the marginal product of the production of good 1 with the interest rate paid by the loan at the preceding period. If the interest rate that you earn owing to the loan is larger than the marginal product of the production of good 1, it will be profitable to increase (at the next period) the amount lent and thus to reduce your production of good 1. And conversely, if the interest rate is lower than the marginal product of good 1. For example, if the marginal product of the production of good 1 is 1.28 and the interest rate that you receive on your loan is 1.13, it will be profitable to reduce your loan and to increase your production of good 1 at the next period.
Decision 2: production of good 2, borrowing on the credit market
To make decision 2, you have to decide the amount of ECUs that you want to borrow on the credit market to invest in the production of good 2. Concretely, you have to enter into the computer the amount that you want to borrow on the credit market.
The amount that you borrow and invest in the production of good 2 earn you the proceeds of the sale of good 2 (quantity produced × price of good 2) but costs you an interest (amount borrowed × interest rate).
You will neither know the price of good 2, nor the interest rate when you make your decision because they result from the decisions of all participants. However, from the second period on, you will know the price and the interest rate of the preceding period, which will allow you to adjust you decision at each period.
During the first period, you have to make your decision with no information on price and interest rate. During the next periods, you have to maximise your payoffs by comparing the marginal product of production of good 2 with the interest rate paid on borrowing. If the interest rate that you pay on your borrowing is larger than the marginal product of the production of good 2, it will be profitable to reduce your borrowing (at the next period) and thereby your production of good 2. And conversely if the interest rate is lower than the marginal product of good 2. For example, if the marginal product of production of good 2 is 1.24 and the interest rate paid on the borrowing is 1.13, it is profitable to increase your borrowing and your production of good 2 at the next period.
Decision 3: consumption of good 1 and good 2
To make decision 3, you have to decide how to allocate your revenue between consumption of good 1 and good 2 in percentage. Consumption of goods 1 and 2 earns a payoff. Concretely, you have to enter into the computer the share between 0.01 and 0.99 of the revenue you would like to allocate to consumption of good 1. The residual share of your revenue, which is 1 minus the value entered, is allocated to consumption of good 2.
Your revenue comes from the production of good 1 and good 2 and from the interest received from your loan minus the interest paid on your borrowing. Your consumption of good 1 and good 2 does not necessarily correspond to your production of good 1 and good 2.
You have to share your consumption between good 1 and good 2 in order to maximise your payoff associated with the consumption of each good. To this aim, you have to compare the relative price of good 2 and good 1 with the marginal relative gain associated with consumption of good 2 and good 1.
You will neither know the relative price of good 2 and good 1 nor the marginal relative gain when you make your decision because they result from the decisions of all participants. However, from the second period on, you will know the relative price and the marginal gain of the preceding period, which will allow you to adjust your decision at each new period.
If the relative price between good 2 and good 1 is larger than the marginal relative gain of consumption of good 2 compared to good 1, it will be profitable to reduce (at the next period) consumption of good 2 and increase consumption of good 1. And conversely, if the relative price between good 2 and good 1 is smaller than the marginal relative gain of good 2 compared to good 1. For example, if good 2 has the same price as good 1 (the relative price between good 2 and good 1 = 1), but good 2 earns you a marginal gain that is twice that of good 1 (marginal relative gain of good 2 compared to that of good 1 = 2), it is profitable to reduce your consumption of good 1 and to increase your consumption of good 2 at the next period.
Running of the experiment
For each of your decisions, once you made your decision, click on the input button. Once you made your 3 decisions, click on Validate to validate your decisions. Once all the participants validate their decisions, the outcome of the period appears on the screen. You will also know the gain associated to decisions 1 and 2, the gain associated to decision 3, the marginal product of good 1, the interest rate realised on the market, the marginal product of production of good 2, the relative price of good 2 compared to good 1, the marginal relative gain of consumption of good 2 compared to good 1, and the total gain per period and cumulated on all the preceding periods.
Steps: initial ECUs and credits
The 45 periods of the experiment are divided in three steps, each composed of 15 periods. These three steps differ by the amount of ECUs you are initially endowed with and by the amount of ECUs offered on the credit market on top of loans granted by all participants.
During the first step (periods 1–15), the initial amount of ECUs each participant is endowed with at each period is 100 ECUs. The total amount of ECUs for each group is thus 600 ECUs at each period (6 participants × 100 ECUs). So you can make your lending decision 1 and your borrowing decision 2 between 0.1 and 99.9.
During the second stage (periods 16–30), the initial amount of ECUs each participant is endowed with at each period is 100 ECUs. Moreover, 240 additional ECUs are offered on the credit market. The total amount of ECUs per group is thus 840 ECUs at each period (6 participants × 100 ECUs + 240 ECUs offered on the credit market). Hence, you can make your lending decision 1 between 0.1 and 99.9 and your borrowing decision 2 between 0.1 and 139.9.
During the third stage (periods 31–45), the initial amount of ECUs of each participant at each period is 140 ECUs. The total amount of ECUs per group is thus 840 ECUs at each period (6 participants × 140 ECUs). Hence, you can make your lending decision 1 and your borrowing decision 2 between 0.1 and 139.9.
Questionnaires
At the beginning of the experiment, you are asked to fill in an understanding questionnaire on the computer; when all the participants have responded properly to this questionnaire, the experiment starts. At the end of the experiment, you are asked to fill in a personal questionnaire on the computer. All information will remain secret.
Payoffs
At the end of the experiment, the ECUs you have obtained are converted into Euros and paid in cash. 350 ECUs correspond to 1 Euro.
If you have any question, please ask them at this time.
Thanks for participating in the experiment!
E Training questionnaire
The training questionnaire varied according to the treatment.[13] We present the questionnaire for a treatment with order of stages: B, C, and L. For the other treatment (B, L, and C), the training questionnaire was adapted accordingly and is available upon request.[14]
Question 1: You interact with other participants at each period.
Answer: You interact with 5 other participants at each period.
Question 2: At each of the periods of the experiment, you have to make decisions.
Answer: At each of the 45 periods of the experiment, you have to make three decisions.
Question 3: The running of steps is the following. You have to make a lending decision between and ECUs and a borrowing decision between and ECUs at step 1, a lending decision between and ECUs and a borrowing decision between and ECUs at step 2, a lending decision between and ECUs and a borrowing decision between and ECUs at step 3.
Answer: You have to make a lending decision between 0.1 and 99.9 ECUs and a borrowing decision between 0.1 and 99.9 ECUs at step 1, a lending decision between 0.1 and 99.9 ECUs and a borrowing decision between 0.1 and 139.9 ECUs at step 2, a lending decision between 0.1 and 139.9 ECUs and a borrowing decision between 0.1 and 139.9 ECUs at step 3.
Question 4: To increase your production of good 1, what shall you do?
Increase your loan in decision 1.
Reduce your loan in decision 1.
Reduce your borrowing in decision 2.
Increase the share of your revenue that you allocate to consumption of good 1 in decision 3.
Answer: Reduce your loan in decision 1.
Question 5: Imagine you are in period 6 of the experiment. At period 5, the interest rate was 3.00 and the marginal product of production of good 1 was 1.02. Compared to period 5, you now choose to:
increase the amount that you lend (and thus reduce your production of good 1).
reduce the amount that you lend (and thus increase your production of good 1).
Answer: increase the amount that you lend (and thus reduce your production of good 1).
Question 6: Imagine you are in period 24 of the experiment. At period 23, the interest rate was 4.25 and the marginal product of production of good 2 was 6.78. Compared to period 23, you now choose to:
increase your borrowing (and thus your production of good 2).
reduce your borrowing (and thus your production of good 2).
Answer: increase your borrowing (and thus your production of good 2).
Question 7: Imagine you are in period 40 of the experiment. At period 39, the relative price between good 2 and good 1 was 5.89 and the relative marginal gain of good 2 compared to good 1 was 4.76. Compared to period 39, you choose to:
increase your consumption of good 1 and reduce your consumption of good 2.
increase your consumption of good 2 and reduce your consumption of good 1.
Answer: increase your consumption of good 1 and reduce your consumption of good 2.
Question 8: What information is at your disposal to make your decisions at period 1?
You will make your decisions in period 1 as in all other periods, by comparing the interest rate with the marginal product of production of good 1 for decision 1, by comparing the interest rate with the marginal product of production of good 2 for decision 2, and by comparing the relative price between good 2 and good 1 and the relative marginal gain of consumption of good 2 compared to good 1 for decision 3.
You will not have any information available in period 1 (solely). The outcome of period 1 will allow you to improve your decisions in period 2, and so on.
Answer: You will not have any information available in period 1 (solely). The outcome of period 1 will allow you to improve your decisions in period 2, and so on.
F Example of screen
Screen.
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Articles in the same Issue
- Smooth operator: remittances and household consumption during fiscal shocks
- Inflation targeting and exchange rate regimes in emerging markets
- Interest rate rules and equilibrium (in)determinacy in a small open economy: the role of internationally traded capital
- Population dynamics and marriage payments: an analysis of the long run equilibrium in India
- Innovation, specialization and growth in a model of structural change
- Learning, robust monetary policy and the merit of precaution
- Profitability and the lifecycle of firms
- Stock vs flow specification of public infrastructures: a dynamic analysis
- The distortionary effect of monetary policy: credit expansion vs. lump-sum transfers in the lab
- “Made in China”: how does it affect our understanding of global market shares?
