The Rationality Bias

Tim Hagenhoff, Joep Lustenhouwer and Mike Tsionas

Journal of Money, Credit and Banking, 2025, vol. 57, issue 2-3, 515-547

Abstract: We analyze differences in consumption and wealth in an estimated New Keynesian model with rational and boundedly rational households. Shocks are shown to cause consumption and wealth heterogeneity due to the “rationality bias” of boundedly rational households. This bias can be decomposed into three components, which, for certain specifications of monetary policy, can exactly offset each other. Moreover, a more hawkish response to inflation leads to more volatility in consumption and wealth heterogeneity, which makes it optimal for the central bank to set lower coefficients in the Taylor rule than would have been the case under homogeneous rational expectations.

Date: 2025
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https://doi.org/10.1111/jmcb.13122

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jmoncb:v:57:y:2025:i:2-3:p:515-547

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