Monetary Policy Simulation Game Yvan Lengwiler WWZ, Economic Theory University of Basel, Switzerland

Learning aim MoPoS is a computer game that allows the user to play the role of a central bank governor. You will confront many of the practical difficulties of monetary policy making. The equations of the simulation model are subject to a flow of shocks. For that reason, you will constantly experience surprises. Your startegy will influence the expectations of the public in this virtual economy, and these expectations affect your trade-offs. Too cautious a policy will not be successful, but behaving in a too activist fashion will also spell trouble.

Structure of the simulation game nominal interest rate real interest rate inflation expectation business cycle inflation IS PC

How to play You will see a "Reuters screen" that contains the essential information about the state of the macroeconomy. You can load prepared scenarios and play from there, or generate new random scenarios from scratch. You manipulate the interest rate and you can observe the effects of these manipulations. Your taks is to steer the economy in order to achieve stability. Can you end a recession? Can you end an inflation? And what do you do in a stagflation?

10 years 2 years

happiness of the public accelerator pedal (interest rate) speed of simulation Taylor rule or manual steering

inflation real interest rate real growth nominal interest rate

Liquidity trap It can happen that the virtual economy falls into a deflationary spiral. Since the inflation rate is strongly negative, the real interest rate will be large even if the nominal interest rate is zero. The nominal interest rate cannot fall below this bound because otherwise, cash would dominate deposits. But the large real interest rate will further contribute to a contraction. The economy is trapped. LIQUIDITY TRAP Monetary policy is powerless.

Liquidity trap

In reality, a true liquidity trap is a very rare phenomenon. It requires the nominal return rates on all assets to vanish. This has probably never happened in history (not even in Japan right now). In the simulation, however, there is only one interest rate, and when this goes to zero and deflation is strong enough — bang! — you cannot escape the trap anymore. So, it is much more likely to experience this trap in the simulation than in real life.

Exercises ä Next you will play the game. ä You can do that on your own or in a group, as you wish. ä Make a protocol of your observations (but keep it short). ä We will discuss your experiences when we reconvene.

Possible exercises ä Load the scenario "stability.sim" (Simulator > Load Simulation…) ã First play the game with the autopilot turned on… ã Observe what the autopilot does. Does it make mistekes? ä Load "stability.sim" again. ã Turn off the autopilot (You are in charge of monetary policy now). ã Try to make smiley happy for as long as possible. ä Load "stability.sim" yet again. ã Now your task is to keep the economy on a stable path and avoid recession and inflation.

Possible exercises ä You can also experiment with other scenarios. ã For instance, there are "recession.sim" and "boom.sim" ã Or you can generate new, random scenarios (with Simulator > Generate Random Scenario). ä In order to share it, or for discussion in class, you can… ã save a simulation (with Simulator > Save Simulation) ã or print it (with File > Print).

Contact Should you have any comments, questions, or suggestions concering MoPoS, please do not hesitate to contact me at Prof. Dr. Yvan Lengwiler University of Basel Dept of Economics (WWZ) 4003 Basel Switzerland