Make-up strategies with incomplete markets and bounded rationality

Michael Dobrew, Rafael Gerke, Sebastian Giesen and Joost Röttger

No 01/2023, Discussion Papers from Deutsche Bundesbank

Abstract: We study the impact of market incompleteness and bounded rationality on the effectiveness of make-up strategies. To do so, we simulate a heterogeneous-agent New Keynesian (HANK) model with reflective expectations and an occasionally-binding effective lower bound (ELB) on the policy rate. Our simulations show that make-up strategies can mitigate the negative consequences of the ELB for inflation and real economic activity. This result holds both for our HANK model as well as a corresponding representative-agent (RANK) model with complete markets, suggesting that market (in)completeness is not important for the effectiveness of make-up strategies. However, the stabilisation benefits of make-up strategies are small when agents' cognitive ability is consistent with micro-evidence. This result is independent of market (in)completeness, emphasising the importance of rational expectations for make-up strategies. Furthermore, while market incompleteness and bounded rationality complement each other in attenuating the effects of forward guidance in our model, we do not observe such a complementarity with respect to the benefits of make-up strategies.

Keywords: Make-Up Strategies; Incomplete Markets; Bounded Rationality; HANK; Effective Lower Bound; Average Inflation Targeting (search for similar items in EconPapers)
JEL-codes: C63 D31 E21 E31 E52 E58 E70 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Make-up strategies with incomplete markets and bounded rationality (2025)
Working Paper: Make-Up Strategies with Incomplete Markets and Bounded Rationality (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:012023

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