the causes of preference reversal observed preference reversal cannot be adequately explained by violations of independence the reduction axiom or transitivity the primary cause of preference reversal is the failure of procedure invariance especially the overpricing of low probability high payoff bets this result violates regret theory and generalized nonindependent utility models preference reversal and a new reversal involving time preferences are explained by scale compatibility which implies that payoffs are weighted more heavily in pricing than in choice copyright 1990 by american economic association

compatibility between monetary and fiscal policy under emu the debate over the stability and growth pact sgp as a part of european monetary union has highlighted the need to assess the extent to which fiscal policies of union members should be constrained as a pre requisite for price stability within the union in this paper we develop a two country open economy model where each country has overlapping generations of finitely lived consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently we examine the case where the two countries have formed a monetary union but where the fiscal authorities remain independent we show that the fiscal response required to ensure stability of the real debt stock is greater when consumers are not infinitely lived in principle this allows for some compensating behaviour between governments but we show that the scope for compensation is limited the monetary authority can abandon its active targeting of inflation to stabilise the debt of at most one fiscal authority and any other combination of policies will either result in price level indeterminacy and or indefinite transfers of wealth between the two economies finally in a series of simulations we show that fiscal shocks have limited impact on output and inflation provided the fiscal authorities meet the weak requirements of fiscal solvency however when monetary policy is forced to abandon its active targeting of inflation then fiscal shocks have a much greater impact on both output and inflation

preference reversals and the independence axiom of all of the paradoxical patterns of behavior reported in laboratory experiments one of the most perplexing for decision theorists is the preference reversal phenomenon a subject in a preference reversal experiment is typically given a choice between a lottery with a high probability of winning a modest amount of money a p bet and a lottery with a low probability of winning a large amount of money a bet the lowest amount of money for which the subject would willingly sell either of these lotteries is also elicited the most common reversal is for a subject to choose the p bet over the bet but to put a higher selling price on the bet preference reversals were first reported by harold lindman 1971 and sarah lichtenstein and paul slovic 1971 in discussing the psychologists discovery of such reversals david grether and charles plott remark the inconsistency is deeper than mere lack of transitivity or even stochastic transitivity it suggests that no optimization principles of any sort lie behind even the simplest of human choices 1979 p 623 this paper offers a simple alternative explanation of documented preference reversals an explanation that does not require the abandonment of the transitivity assumption

fiscal policy rules in an overlapping generations model with endogenous labour supply abstract a fiscal policy rule in which taxation is a function of the stock of government debt a wealth tax is usually believed to be effective in providing stability using a discrete time version of the blanchard 1985 debt deficits and finite horizons journal of political economy 93 223 247 overlapping generations model extended to include an endogenous labour supply we show that contrary to the conventional wisdom a wealth tax might not be enough to ensure the existence of a unique well defined steady state we suggest that a government willing to run a positive and sustainable level of debt could use an alternative rule a fiscal taylor rule in which another taxation component that takes in to account the level of the real interest rate is added

interactions between monetary and fiscal policy rules the fiscal stability pact for emu implies that constraints on fiscal policy facilitate inflation control in this paper we identify two stable policy regimes when monetary policy seeks to raise real interest rates in response to excess inflation a self stabilising fiscal policy is required to ensure model stability a fiscal policy which does not by itself ensure fiscal solvency constrains monetary policy to be relatively passive however in simulations we conclude that the central bank does not need to seek on this account the degree of debt stabilisation that appears to be implied by the fiscal stability pact

optimal fiscal feedback on debt in an economy with nominal rigidities we examine the impact of different degrees of fiscal feedback on debt in an economy with nominal rigidities where monetary policy is optimal we look at the extent to which different degrees of fiscal feedback enhances or detracts from the ability of the monetary authorities to stabilise output and inflation using an objective function derived from utility we find the optimal level of fiscal feedback to be small there is a clear discontinuity in the behaviour of monetary policy and welfare either side of this optimal level as the extent of fiscal feedback increases optimal monetary policy becomes less active because fiscal feedback tends to deflate inflationary shocks however this fiscal stabilisation is less efficient than monetary policy and so welfare declines in contrast if fiscal feedback falls below some critical value either the model becomes indeterminate or optimal monetary policy becomes strongly passive and this passive monetary policy leads to a sharp deterioration in welfare

preference reversals under ambiguity preference reversals have been widely studied using risky or riskless gambles however little is known about preference reversals under ambiguity unknown probabilities subjects were asked to make a binary choice between ambiguous p bets big likelihood of giving small prize and ambiguous bets small likelihood of giving large prize and their willingness to accept was elicited subjects then performed the same two tasks with risky bets where the probability of winning for a given risky bet is the center of the probability interval of the corresponding ambiguous bet preference reversals are not only replicated under ambiguity but are even stronger than are those under risk this is due to higher elicited prices for the bet and lower elicited prices for the p bet under ambiguity than under risk this result can be explained by the shape of the weighting function for different levels of uncertainty and for different elicitation modes this paper was accepted by peter wakker decision analysis

economic theory of choice and the preference reversal phenomenon a reexamination in a recent issue of this review david grether and charles plott 1979 hereinafter referred to as g p presented a series of experiments that show that individual decisions are made in a manner inconsistent with standard preference theory this inconsistency can be illustrated by the following example individuals under suitable laboratory conditions first have a choice between a lottery with a high probability of winning a small sum of money the p bet probability bet and a lottery with a high stake but low probability of winning the m bet money bet after indicating a preference for one of the lotteries in the pair the same subjects are then asked to place a monetary value on each of the individual lotteries grether and plott found that a large number of participants stated a preference for the p bet in the first round but placed a higher value on the other lottery the m bet in the second round this behavior a preference reversal is inconsistent with the traditional statements of preference theory

stock market conditions and monetary policy in a dsge model for the u s abstract this paper investigates the interactions between stock market fluctuations and monetary policy within a dsge model for the u s economy first we design a framework in which fluctuations in households financial wealth are allowed but not necessarily required to exert an impact on current consumption this is due to the interaction in the financial markets of long time traders holding wealth accumulated over time with newcomers holding no wealth at all importantly we introduce nominal wage stickiness to induce pro cyclicality in real dividends additional nominal and real frictions are modeled to capture the pervasive macroeconomic persistence of the observables employed to estimate our model we fit our model to post wwii u s data and report three main results first the data strongly support a significant role of stock prices in affecting real activity and the business cycle second our estimates also identify a significant and counteractive response of the fed to stock price fluctuations third we derive from our model a microfounded measure of financial slack the stock price gap which we then contrast to alternative ones currently used in empirical studies to assess the properties of the latter to capture the dynamic and cyclical implications of our dsge model the behavior of our stock price gap is consistent with the episodes of stock market booms and busts occurred in the post wwii as reported by independent analyses and closely correlates with the current financial meltdown typically employed proxies of financial slack such as detrended log indexes or growth rates show limited capabilities of capturing the implications of our model consistent index of financial stress cyclical properties of the model as well as counterfactuals regarding shocks to our measure of financial slackness and monetary policy shocks are also proposed

preference paradoxes and lexicographic choice abstract results of various experiments reported in the literature have shown repeated violations of expected utility theory this paper presents a model of lexicographic choice under uncertainty that has the probability of gain or at least no loss and the best possible outcome as well as expected utility as determinants of choice under different conditions the model easily explains the observed violations and other curious preference patterns including the allais and ellsberg paradoxes probalistic insurance preference reversals preference cycles and the reflection isolation and translation effects despite its explanatory power the model is as testable as the expected utility hypothesis

learning monetary policy and asset prices this working paper should not be reported as representing the view s of the imf the views expressed in this working paper are those of the author s and do not necessarily represent those of the imf or imf policy working papers describe research in progress by the author s and are published to elicit comments and to further debate

the effectiveness of government debt for demand management sensitivity to monetary policy rules abstract we construct a staggered price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes price stickiness plus lack of ricardian equivalence could be expected to make an increase in government debt with associated changes in lump sum taxation effective in raising short run output however we find this is very sensitive to the monetary policy rule a permanent increase in debt under a basic taylor rule does not raise output to make debt effective we need either a temporary nominal interest rate peg or inertia in the rule or an exogenous money supply policy or to make the debt increase temporary

taxation and capital structure choice evidence from a panel of german multinationals this paper analyzes the impact of taxes and lending conditions on the financial structure of multinationals foreign affiliates the empirical analysis employs a large panel of affiliates of german multinationals in 26 countries in the period from 1996 until 2003 in accordance with the theoretical predictions the effect of local taxes on leverage is positive for both types of debt moreover while adverse local credit market conditions are found to reduce external borrowing internal debt is increasing supporting the view that the two channels of debt finance are substitutes

preference reversals without the independence axiom the preference reversal phenomenon was believed to be inconsistent with the transitivity axiom of decision theory however recent theoretical papers have demonstrated that the preference reversals that were observed in earlier experiments could be explained by subject violations of the independence axiom or the compound lottery axiom therefore those preference reversals are not known to be inconsistent with generalization of expected utility theory that replace the independence axiom the present paper reports the results of experiments in which a substantial proportion of subject responses violate the asymmetry axiom these results are inconsistent with expected utility theory and its generalizations copyright 1989 by american economic association

experimental economics hard science or wasteful tinkering i take it that in raising the question what have we learned from experimental economics under the broader umbrella of controversy the point is not to solicit a catalogue of experimental findings but rather to signal the more pointed question are we learning anything at all or at least much that is very useful form experimentation in economics as a practising experimentalist i am convinced that experiments do have the potential to make a significant contribution to knowledge in economics this abstract was borrowed from another version of this item

inflation targeting fiscal rules and the policy mix cross effects and interactions we examine how inflation targeting it and fiscal rules fr affect inflation and fiscal performance in a large panel of countries during 1990 2009 in line with theory both fr and it appear to shape monetary and fiscal outcomes significant cross effects seem to exist as it strengthens fiscal performance whereas the combination of fr and it tends to be associated with more disciplined macroeconomic policies than if only one of these institutions operates our findings suggest that it and fr affect the coordination of the policy mix and point to potential benefits of reforming macroeconomic frameworks in a holistic fashion

what should fiscal councils do fiscal watchdogs so called fiscal councils have been proposed as a method to counter deficit bias of fiscal policy the paper analyses theoretically what role fiscal councils could play and surve

observing violations of transitivity by experimental methods the preference reversal phenomenon is usually interpreted as evidence of nontransitivity of preference but has also been explained as the result of the difference between individuals responses to choice and valuation problems the devices used by experimenters to elicit valuations and the random lottery selection incentive system this paper reports an experiment designed so that none of these factors could generate systematic nontransitivities yet systematic violations of transitivity were still found the pattern of violation was analogous with that found in previous preference reversal experiments and is consistent with regret theory copyright 1991 by the econometric society

monetary policy and asset prices with belief driven fluctuations abstract we present a heterogeneous agents new keynesian model subject to a cost channel of monetary policy transmission constant turnover between long time traders and newcomers in market activities combined with restricted trading opportunities introduces a feedback from the stock market to real activity making stock prices non redundant for the business cycle we show that strict inflation targeting can lead to equilibrium indeterminacy even if the policy rule satisfies the taylor principle a belief driven shock to stock price generates relative volatilities of key financial variables which are very close to what is observed in u s data this result hints to the possibility that the financial instability witnessed since the mid to late 1990s was the result of waves of rational exuberance and pessimism in financial markets our analysis suggests that a mild response to stock prices in the central bank s policy rule can restore equilibrium determinacy and therefore rule out non fundamental volatility

preference reversal real world lotteries and lottery interested subjects prefer lce reversal or choice reservation price inconsistency has been documented experimentally for zrtain types of lotteries we argue that the relevance of these findings for realworld markets is uncertain because the type of objects used cannot exist on a market and because the extent to which the subjects had any real interest in the objects is unknown using reai world lotteries we have tested choice price consistency on subjects who prefer lotteries ta cash preference reversal was observed but the frequency was much lower than in earlier experiments there were no differences between subjects who qualified as lottery interested and those who did not 1 intmduction

the effects of payoff magnitude and heterogeneity on behavior in 2 2 games with unique mixed strategy equilibria the logit version of quantal response equilibrium predicts that equilibrium behavior in games will vary systematically with payoff magnitudes if all other factors are held constant including the nash equilibria of the game we explore this in the context of a set of asymmetric 2x2 games with unique totally mixed strategy equilibria the data provide little support for the payoff magnitude predictions of the logit equilibrium model we extend the theoretical quantal response equilibrium model to allow for heterogeneity and find that the data fit the heterogeneous version of the theory significantly better

choice under uncertainty problems solved and unsolved ffifteen years ago the theory of choice under uncertainty could be considered one of the success stories of economic analysis it rested on solid axiomatic foundations it had seen important breakthroughs in the analytics of risk risk aversion and their applications to economic issues and it stood ready to provide the theoretical underpinnings for the newly emerging information revolution in economics 1 today choice under uncertainty is a field in flux the standard theory is being challenged on several grounds from both within and outside economics the nature of these challenges and of our profession s responses to them is the topic of this paper

fiscal stabilization policy and fiscal institutions in this paper we analyse counter cyclical fiscal policy within the context of a microfounded analysis of business cycle stabilization we show that tax and spending instruments can have a useful counter cyclical role even after allowing for the distortionary nature of the instruments and the need for debt sustainability a critical barrier to the use of fiscal instruments may be political economy concerns and we survey recent suggestions involving alternative fiscal policy institutions

debt nonneutrality policy interactions and macroeconomic stability we study the consequences of non neutrality of government debt for macroeconomic stabilization policy in an environment where prices are sticky assuming transaction services of government bonds ricardian equivalence fails because public debt has a negative impact on its marginal rate of return and thus on private savings stability of equilibrium sequences requires a stationary evolution of real public debt which steers inflation expectations and rules out endogenous fluctuations under anti inflationary monetary policy regimes macroeconomic fluctuations tend to decrease with the share of tax financing which justifies tight debt constraints in particular a balanced budget policy stabilizes the economy under cost push shocks such that output and inflation variances can be lower than in a corresponding case where debt is neutral

preference reversals the impact of truth revealing monetary incentives researchers vigorously debate the impact of incentives in preference reversal experiments do incentives alter behavior and generate economically consistent choices lichtenstein and slovic 1971 document inconsistencies reversals in revealed preference in gamble pairs across paired choice and individual pricing tasks the observed pattern is inconsistent with stable underlying preferences expressed with simple errors lichtenstein and slovic 1973 and grether and plott 1979 introduce incentives but aggregate reversal rates change little these results fostered numerous replications and assertions that models of non stable preferences are required to explain reversals contrary to this research we find that incentives can generate more economically consistent behavior our reevaluation of existing experimental data shows that incentives have a clear impact by better aligning aggregate choices and prices the effect is sufficiently large that with truth revealing incentives a stable preferences with error model not only explains behavior but fits the data as well as any model possibly could

examining risk preferences under high monetary incentives experimental evidence from the people s republic of china several experimental sessions were conducted to elicit certainty equivalents for a sequence of lotteries involving real monetary outcomes the opportunity to conduct sessions in the people s republic of china afforded the ability to offer very large monetary incentives relative to subjects living costs in the highest payoff condition subjects earned three times their normal monthly revenue in the course of a two hour experiment results indicate a statistically significant impact of the level of monetary incentives on revealed risk preferences however even under extreme monetary incentives subjects demanded amounts well in excess of expected value for low probability gain prospects copyright 1992 by american economic association

pre play learning and the preference reversal phenomenon elicited preference rankings for two lotteries are typically inconsistent across choice and pricing tasks we test whether pre play learning makes preference rankings consistent pre play learning denotes ex ante lottery learning where subjects observe playing lotteries before making decisions we find that pre play learning makes the average selling prices for the p bet of subjects who choose the p bet higher than their average selling prices for the bet however pre play learning is not strong enough to equalize the rates of standard and non standard reversals although pre play learning reduces the rate of standard reversals