Monetay Policy, Bounded Rationality, and Incomplete Markets

Emmanuel Farhi and Iván Werning

No 768, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper extends the benchmark New-Keynesian model by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally- binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is much more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model.

Date: 2018
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Monetary Policy, Bounded Rationality, and Incomplete Markets (2019)
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017)
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:768

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