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Fiscal Policy Perceptions in a Behavioral New Keynesian Model

Author

Listed:
  • Thomas A. Lubik

    (Research Department, Federal Reserve Bank of Richmond)

  • Massimiliano Marzo

    (Department of Management, University of Bologna)

Abstract

We study misperceptions of fiscal policy in a New Keynesian model based on the imperfect cognition framework of Gabaix (2020), where agents have limited ability to forecast future macroeconomic variables. We derive three main insights. First, we document the failure of Ricardian equivalence under misperception as the main transmission channel of shocks. Second, monetary policy has a weakened impact on macroeconomic variables when compared with the full information case. Third, we propose an endogenization of the cognitive parameters as an extension to Gabaix (2020). Robustness analysis reveals how households' cognitive ability plays a dominant role in affecting the size of macroeconomic fluctuations.

Suggested Citation

  • Thomas A. Lubik & Massimiliano Marzo, 2021. "Fiscal Policy Perceptions in a Behavioral New Keynesian Model," Annals of Economics and Finance, Society for AEF, vol. 22(2), pages 255-287, November.
    • Handle: RePEc:cuf:journl:y:2021:v:22:i:2:lubikmarzo
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    References listed on IDEAS

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    3. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-2872, October.
    4. Xavier Gabaix, 2014. "A Sparsity-Based Model of Bounded Rationality," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(4), pages 1661-1710.
    5. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    6. George W. Evans, 2001. "Expectations in Macroeconomics. Adaptive versus Eductive Learning," Revue Économique, Programme National Persée, vol. 52(3), pages 573-582.
    7. Xavier Gabaix, 2020. "A Behavioral New Keynesian Model," American Economic Review, American Economic Association, vol. 110(8), pages 2271-2327, August.
    8. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-399.
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    10. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-1311, July.
    11. Massaro, Domenico, 2013. "Heterogeneous expectations in monetary DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 37(3), pages 680-692.
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    More about this item

    Keywords

    Imperfect Cognition; Euler-equation; Phillips curve; Monetary Policy; Fiscal Policy; Ricardian Equivalence; Macroeconomic Fluctuations;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General

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