Resolving New Keynesian Anomalies with Wealth in the Utility Function

80 Pages Posted: 12 May 2021 Last revised: 25 Sep 2021

See all articles by Pascal Michaillat

Pascal Michaillat

Brown University

Emmanuel Saez

University of California, Berkeley

Date Written: August 2018

Abstract

At the zero lower bound, the New Keynesian model predicts that output and inflation collapse to implausibly low levels, and that government spending and forward guidance have implausibly large effects. 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 status. Since people partly save 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 zero-lower-bound equilibrium transforms from a saddle to a source—which resolves all the anomalies.

Suggested Citation

Michaillat, Pascal and Saez, Emmanuel, Resolving New Keynesian Anomalies with Wealth in the Utility Function (August 2018). NBER Working Paper No. w24971, Available at SSRN: https://ssrn.com/abstract=3844282

Pascal Michaillat (Contact Author)

Brown University

Box 1860
Providence, RI 02912
United States

Emmanuel Saez

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

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