Behavioral Macroeconomics via Sparse Dynamic Programming

135 Pages Posted: 20 Dec 2015

See all articles by Xavier Gabaix

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 3 versions of this paper

Date Written: December 19, 2015

Abstract

This paper proposes a tractable way to model boundedly rational dynamic programming. The agent uses an endogenously simplified or "sparse" model of the world and the consequences of his actions, and act according to a behavioral Bellman equation. The framework is applied to some of the canonical models in macroeconomics and finance.

In the consumption-savings model, the consumer decides to pay little or no attention to the interest rate and more attention to his income. Ricardian equivalence and the Lucas critique partially fail, because the consumer is only partially attentive to taxes and policy changes.

The model also yields a behavioral version of the New Keynesian model. It helps solve the "forward guidance puzzle", the fact that in that model, shocks to very distant rates have a very powerful impact on today's consumption and inflation: because the agent is de facto myopic, this effect is muted.

The paper gives a behavioral version of the canonical neoclassical growth model: fluctuations are larger and more persistent as agents do not react optimally to macroeconomic variables. Finally, in a Merton-style dynamic portfolio choice problem, the agent endogenously pays limited or no attention to the varying equity premium and hedging demand terms.

Keywords: Bounded rationality, inattention

JEL Classification: D03, E03, E6, E21, G02

Suggested Citation

Gabaix, Xavier, Behavioral Macroeconomics via Sparse Dynamic Programming (December 19, 2015). Available at SSRN: https://ssrn.com/abstract=2705789 or http://dx.doi.org/10.2139/ssrn.2705789

Xavier Gabaix (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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