Short-term Planning, Monetary Policy, and Macroeconomic Persistence

Christopher Gust, Edward Herbst and David Lopez-Salido

No 2020-003, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper uses aggregate data to estimate and evaluate a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model commonly used in empirical applications as well as other behavioral NK models. The better fit of the FH model reflects that it can induce slow-moving trends in key endogenous variables which deliver substantial persistence in output and inflation dynamics. In the FH model, households and firms are forward-looking in thinking about events over their planning horizon but are backward looking regarding events beyond that point. This gives rise to persistence without resorting to additional features such as habit persistence and price contracts indexed to lagged inflation. The parameter estimates imply that the planning horizons of most households and firms are less than two years which considerably dampens the effects of expected future changes of monetary policy on the macroeconomy.

Keywords: Finite-horizon planning; Learning; Monetary policy; New keynesian model; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: C11 E52 E70 (search for similar items in EconPapers)
Pages: 46 p.
Date: 2020-01-08
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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https://www.federalreserve.gov/econres/feds/files/2020003pap.pdf (application/pdf)

Related works:
Journal Article: Short-Term Planning, Monetary Policy, and Macroeconomic Persistence (2022)
Working Paper: Short-term Planning, Monetary Policy, and Macroeconomic Persistence (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2020-03

DOI: 10.17016/FEDS.2020.003

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