Resolving New Keynesian Anomalies with Wealth in the Utility Function

70 Pages Posted: 11 Jun 2019

See all articles by Pascal Michaillat

Pascal Michaillat

Brown University - Department of Economics

Emmanuel Saez

University of California, Berkeley

Date Written: June 2019

Abstract

The New Keynesian model makes several anomalous predictions at the zero lower bound: collapse of output and inflation, and implausibly large effects of forward guidance and government spending. To resolve these anomalies, we introduce wealth into the utility function. The justification is that wealth is a marker of social status, and people value social status. Since people save not only for future consumption but also to accrue social status, the Euler equation is modified. As a result, when the marginal utility of wealth is sufficiently large, the dynamical system representing the equilibrium at the zero lower bound becomes a source instead of a saddle-which resolves all the anomalies.

JEL Classification: E32, E52, E62

Suggested Citation

Michaillat, Pascal and Saez, Emmanuel, Resolving New Keynesian Anomalies with Wealth in the Utility Function (June 2019). CEPR Discussion Paper No. DP13775. Available at SSRN: https://ssrn.com/abstract=3401862

Pascal Michaillat (Contact Author)

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

HOME PAGE: http://www.pascalmichaillat.org

Emmanuel Saez

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

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