Balancing the current account: experimental evidence on underconsumption
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How should countries in a fixed exchange rate system balance their current account? This question was at the center of the historical debate between Keynes and White in 1944 and is being debated increasingly these days for the Eurozone. Should consolidation by deficit countries be complemented by higher spending in surplus countries in order to avoid a downward bias in the level of consumption? We investigate the associated disequilibrium behavior experimentally, letting our experimental subjects act as heads of state who repeatedly seek to coordinate their policies. If only deficits are punished, as proposed by White, we observe that consumption is persistently reduced and adjustment is slower than in a treatment in which a surplus is also punished, as suggested by Keynes. We find support for the fact that underconsumption occurs for behavioral but not for rational reasons.
KeywordsBeauty contest Current account imbalance White Plan Keynes Plan Deflationary bias Level-k reasoning Eurozone
JEL ClassificationF32 E12 C92
The authors are grateful to John Duffy, Christian Engelen, Susanna Grundmann, Frank Heinemann, Oliver Landmann, Rosemarie Nagel, Manuel Schubert, Günther Schulze, Jean-Robert Tyran, two anonymous referees and participants of the 3rd LeeX International Conference on Theoretical and Experimental Macroeconomics, Barcelona, June 2012, the economic seminar at Freiburg University, January 2013, the Vienna Center for Experimental Economics, January 2013 and the Gesellschaft für experimentelle Wirtschaftsforschung GfeW, October 2013.
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