A Behavioral New Keynesian Model

71 Pages Posted: 3 Jan 2017

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 2 versions of this paper

Date Written: December 2016

Abstract

This paper presents a framework for analyzing how bounded rationality affects monetary and fiscal policy. The model is a tractable and parsimonious enrichment of the widely-used New Keynesian model - with one main new parameter, which quantifies how poorly agents understand future policy and its impact. That myopia parameter, in turn, affects the power of monetary and fiscal policy in a microfounded general equilibrium.

A number of consequences emerge. (i) Fiscal stimulus or "helicopter drops of money" are powerful and, indeed, pull the economy out of the zero lower bound. More generally, the model allows for the joint analysis of optimal monetary and fiscal policy. (ii) The Taylor principle is strongly modified: even with passive monetary policy, equilibrium is determinate, whereas the traditional rational model yields multiple equilibria, which reduce its predictive power, and generates indeterminate economies at the zero lower bound (ZLB). (iii) The ZLB is much less costly than in the traditional model. (iv) The model helps solve the "forward guidance puzzle": the fact that in the rational model, shocks to very distant rates have a very powerful impact on today's consumption and inflation: because agents are partially myopic, this effect is muted. (v) Optimal policy changes qualitatively: the optimal commitment policy with rational agents demands "nominal GDP targeting"; this is not the case with behavioral firms, as the benefits of commitment are less strong with myopic firms. (vi) The model is "neo-Fisherian" in the long run, but Keynesian in the short run: a permanent rise in the interest rate decreases inflation in the short run but increases it in the long run. The non-standard behavioral features of the model seem warranted by the extant empirical evidence.

Keywords: behavioral macroeconomics, bounded rationality, forward guidance, price level targetting, zero lower bound

JEL Classification: D03, E03, E12, E52, E6, E62, E63, G02

Suggested Citation

Gabaix, Xavier, A Behavioral New Keynesian Model (December 2016). CEPR Discussion Paper No. DP11729. Available at SSRN: https://ssrn.com/abstract=2893082

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

Register to save articles to
your library

Register

Paper statistics

Downloads
1
Abstract Views
382
PlumX Metrics