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Behavioral Macroeconomics Via Sparse Dynamic Programming

Xavier Gabaix

No 11026, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper proposes a tractable way to model boundedly rational dynamic programming. The agent uses an endogenously simplified, or "sparse," model of the world and the consequences of his actions and acts according to a behavioral Bellman equation. The framework yields a behavioral version of some of the canonical models in macroeconomics and finance. In the life-cycle model, the agent initially does not pay much attention to retirement and undersaves; late in life, he progressively saves more, generating realistic dynamics. In the consumption-savings model, the consumer decides to pay little or no attention to the interest rate and more attention to his income. Ricardian equivalence and the Lucas critique partially fail because the consumer may not pay full attention to taxes and policy changes. In a Mertonstyle dynamic portfolio choice problem, the agent endogenously pays limited or no attention to the varying equity premium and hedging demand terms. Finally, in the neoclassical growth model, agents act on a simplified model of the macroeconomy; in equilibrium, fluctuations are larger and more persistent.

Keywords: Bounded rationality; inattention; simplification (search for similar items in EconPapers)
JEL-codes: D03 E03 E21 E6 G02 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2015-12
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Working Paper: Behavioral Macroeconomics Via Sparse Dynamic Programming (2016) Downloads
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