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Monetay Policy, Bounded Rationality, and Incomplete Markets

Emmanuel Farhi () and Iván Werning

No 768, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper extends the benchmark New-Keynesian model by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally- binding borrowing constraints; and (2) 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 much 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.

New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
Date: 2018
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https://economicdynamics.org/meetpapers/2018/paper_768.pdf (application/pdf)

Related works:
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017) Downloads
Working Paper: Monetary Policy, Bounded Rationality, and Incomplete Markets (2017) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:768

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