Make-up strategies with incomplete markets and bounded rationality

Michael Dobrew, Rafael Gerke, Sebastian Giesen and Joost Röttger

European Economic Review, 2025, vol. 173, issue C

Abstract: We study the impact of market incompleteness and bounded rationality on the effectiveness of make-up strategies. Using a heterogeneous-agent New Keynesian model with reflective expectations, we show that make-up strategies can mitigate the negative consequences of an occasionally-binding effective lower bound. However, the benefits are small when cognitive ability is in line with micro-evidence. These findings are independent of market (in)completeness, emphasising the importance of rational expectations. While market incompleteness and bounded rationality complement each other in attenuating the effects of forward guidance, we do not observe such a complementarity for the effectiveness of make-up strategies.

Keywords: Make-up strategies; Incomplete markets; Bounded rationality; Effective lower bound; Average inflation targeting (search for similar items in EconPapers)
JEL-codes: C63 D31 E21 E52 E58 E70 (search for similar items in EconPapers)
Date: 2025
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Related works:
Working Paper: Make-up strategies with incomplete markets and bounded rationality (2023)
Working Paper: Make-Up Strategies with Incomplete Markets and Bounded Rationality (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:173:y:2025:i:c:s0014292124002708

DOI: 10.1016/j.euroecorev.2024.104941

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