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A SUMMARY OF “ARE TWO HEADS BETTER THAN ONE?: AN EXPERINMENTAL ANALYIS OF GROUP VS INDIVIDUAL DECISIONMAKING” by Blinder, A.S. and J. Morgan, NBER Working Paper, 7909, 2000 12-July-2006 The two central questions for this paper are: 1) Do groups reach decisions more slowly than individuals do? And are group decisions, on average, better or worse than individual decisions? The authors constructed two laboratory experiments in which everything was kept equal except the nature of the decision-making—they compared an individual versus a group answer to certain questions. Each group consisted of five people who also participated as individuals. The experiments did not support the commonly-held belief that groups reach decisions more slowly than individuals and found that groups, on average, made better decisions than individuals. In the first experiment, a purely statistical experiment was conducted without any economic content. This experiment was a type of classic “urn problem” where subjects sample from an urn and are asked to estimate its composition. “Electronic urns” were created, consisting initially of 50 per cent blue balls and 50 per cent red balls. At some randomly chosen point in the experiment, the composition of the urn would be changed to either 70 percent blue balls and 30 per cent red balls, or to 70 per cent red and 30 per cent blue without telling the subjects when the change took place and in which direction. The subjects were asked to guess at which direction the change occurred. In the second experiment, subjects were asked to steer an economy by manipulating the interest rate. Neither experiment supported the commonly-held belief that groups reach decisions more slowly than individuals and both of them found that groups, on average, made better decisions than individuals. Furthermore, they did not find any differences between group decisions made by majority rule and group decisions made under a unanimity requirement. In this note, the monetary policy experiment will be summarised and its findings will be given, in detail. The Monetary Policy Experiment In this experiment, the subjects played the role of policy makers. The sequences of the monetary policy game are given as follows: 1) Instructions, 2) Practice rounds ( no score recorded), 3) Part One: 10 rounds played as individuals, 4) Part Two: 10 rounds played as a group under majority rule (alternatively, under unanimity), Part Three: 10 rounds played as individuals, Part Four: 10 rounds played as a group under unanimity (alternatively, under majority rule). The authors programmed each computer with a simple two-equation macroeconomic model, which is very popular in the recent literature on monetary policy. The model is given in the appendix. The experimental subjects controlled the nominal interest rates and the played the role of the Central Bank. In this experiment, fiscal expenditures (G) change randomly. Experimental subjects were supposed to recognize changes in G and react to this change, with a lag, by raising or lowering the nominal interest rate. G starts at zero and randomly changes to either + 0.3 or – 0.3 at sometime within the first 10 periods. The experiment begins with 2 per cent inflation, which is the inflation target. The shock, the change in government expenditures (G) changes the unemployment rate at the same amount but in the opposite direction according to the equation (1). From equation (2), we see that changes in unemployment rate change inflation rate in the opposite direction. Changes in the inflation rate change the real interest rate in the opposite direction, when other variables are kept constant. In this model, monetary policy affects inflation indirectly, with a distributed lag, which begins two periods later. When G increases, if it is not stabilized by monetary policy, the model diverges from equilibrium. For example, when G increases, unemployment decreases, then inflation increases and if the central bank does not raise nominal interest rates, the real interest rate declines further and stimulates the economy more. In each play, at the beginning, the system is at the steady state equilibrium with Gt = 0, current and lagged nominal interest rates at 7 per cent ( 5 per cent real rate and 2 per cent inflation target), lagged unemployment rate is 5 per cent, all the lagged inflation rates are 2 per cent. The computer calculated the first-period values for the unemployment and inflation rates, these figures appeared on the screen. For each subsequent period, new random values of et and wt are drawn, which create statistical noise. The computer calculates Ut and ∏t and shows them on the screen, with all past values. Subjects are then asked to choose an interest rate for the next period. At some period chosen at random from a uniform distribution between t=1 and t=10, Gt is either increased to + 0.3 or decreased to -0.3. (Whether G rises or falls is also decided randomly). Subjects are not told when G changes and its direction. However, students are told that the probability laws that govern the changes. Each play of the game continues for 20 periods. Each period is considered as a quarter. To evaluate the quality of the decisions, the following absolute- value loss function is defined: st = 100 – 10 │Ut – 5│– 10 │∏t -2 │ 2 The score for the whole game (S), is calculated as the unweighted average of st over the 20 quarters. At the end of the entire session, scores are converted into money at the exchange rate of 25 cents for each percentage point. Theoretically, the maximum amount that can be earned is $ 25. Subjects may receive several false signals before G actually changes. A two-standard deviation et shock appears like a negative G shock; although changes in G are permanent and et shock is temporary. Moreover, subjects are not allowed to know the size of the G shock and the standard deviations of et and wt. Subjects change the interest rate up and down almost every period, this type of response makes it difficult to measure the decision lag in monetary policy. That is because; subjects are charged a fixed cost of 10 points each time when they change the rate of interest. Students can communicate freely as much as they want, during group play, but they cannot communicate with each other during individual play. In the monetary policy game context, regarding the hypothesis H1= groups make decisions more slowly than individuals; the authors did not find any support for this hypothesis. Moreover, regarding the hypothesis, H2= groups make better decisions than individuals; they found that group decisions were superior to individual decisions without being slower. They did not find any difference between groups operating under majority rule and groups operating under unanimity rule. Hence, they could not support the hypothesis H3= decisions by majority rule are made faster than under a unanimity requirement. Appendix The model: (1) Ut – 5 = 0.6 (U t-1 - 5) + 0.3 ( i t-1 – ∏ t-1 – 5 ) – Gt + et (2) ∏t = 0.4 ∏ t-1 + 0.3 ∏ t-2 +0.2 ∏ t-3 +0.1 ∏ t-4 –0.5 (U t-1 - 5) + wt where U is the unemployment rate, the assumed “natural rate” is 5 %, i is the nominal interest rate and ∏ is the rate of inflation, G indicates the fiscal expenditures. The equilibrium real interest rate is set at 5 %. Parameter values were chosen from the US economy, not estimated. Equation (1) can be considered as a reduced form combining an IS curve with Okun’s Law. Higher (lower) real interest rates will increase (decrease) unemployment. Equation (2) is a standard accelerationist Phillips curve. In this model, inflation depends on the lagged unemployment rate and on its four lagged values, with weights summing to one. The weighted average of past inflation rates can be thought of as representing expected inflation. 3 In this experiment, there are two stochastic shocks, et and wt, and they are drawn from uniform distributions on the interval [-0.25, +0.25]. Their standard deviations are approximately 0.14, or about half the size of the G shock. 4