Behavioral Macroeconomics Via Sparse Dynamic Programming

55 Pages Posted: 12 Jan 2016 Last revised: 16 Jan 2016

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)

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Date Written: January 2016

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 acts according to a behavioral Bellman equation. The framework yields a behavioral version of some of the canonical models in macroeconomics and finance. In the life-cycle model, the agent initially does not pay much attention to retirement and undersaves; late in life, he progressively saves more, generating realistic dynamics. 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 may not pay full attention to taxes and policy changes. 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. Finally, in the neoclassical growth model, agents act on a simplified model of the macroeconomy; in equilibrium, fluctuations are larger and more persistent.

Suggested Citation

Gabaix, Xavier, Behavioral Macroeconomics Via Sparse Dynamic Programming (January 2016). NBER Working Paper No. w21848. Available at SSRN: https://ssrn.com/abstract=2713572

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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