A Behavioral New Keynesian Model

Xavier Gabaix

No 11729, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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; Zero lower bound; Forward guidance; Price level targetting (search for similar items in EconPapers)
JEL-codes: D03 E03 E12 E52 E6 E62 E63 G02 (search for similar items in EconPapers)
Date: 2016-12
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-upt
References: Add references at CitEc
Citations: View citations in EconPapers (130)

Downloads: (external link)
https://cepr.org/publications/DP11729 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: A Behavioral New Keynesian Model (2020)
Working Paper: A Behavioral New Keynesian Model (2016)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:11729

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP11729

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().