Monetary Policy, Bounded Rationality, and Incomplete Markets

Emmanuel Farhi and Iván Werning

American Economic Review, 2019, vol. 109, issue 11, 3887-3928

Abstract: This paper extends the benchmark New-Keynesian model by introducing two frictions: (i) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (ii) 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 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.

JEL-codes: D52 D81 E12 E52 (search for similar items in EconPapers)
Date: 2019
Note: DOI: 10.1257/aer.20171400
References: Add references at CitEc
Citations: View citations in EconPapers (133)

Downloads: (external link)
https://www.aeaweb.org/doi/10.1257/aer.20171400 (application/pdf)
https://www.aeaweb.org/doi/10.1257/aer.20171400.data (application/zip)
https://www.aeaweb.org/doi/10.1257/aer.20171400.appx (application/pdf)
https://www.aeaweb.org/doi/10.1257/aer.20171400.ds (application/zip)
Access to full text is restricted to AEA members and institutional subscribers.

Related works:
Working Paper: Monetay Policy, Bounded Rationality, and Incomplete Markets (2018)
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017)
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017)
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:aea:aecrev:v:109:y:2019:i:11:p:3887-3928

Ordering information: This journal article can be ordered from
https://www.aeaweb.org/journals/subscriptions

Access Statistics for this article

American Economic Review is currently edited by Esther Duflo

More articles in American Economic Review from American Economic Association Contact information at EDIRC.
Bibliographic data for series maintained by Michael P. Albert ().