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Make-up strategies with incomplete markets and bounded rationality

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  • Dobrew, Michael
  • Gerke, Rafael
  • Giesen, Sebastian
  • Röttger, Joost

Abstract

We study the impact of market incompleteness and bounded rationality on the effectiveness of make-up strategies. Using a heterogeneous-agent New Keynesian model with reflective expectations, we show that make-up strategies can mitigate the negative consequences of an occasionally-binding effective lower bound. However, the benefits are small when cognitive ability is in line with micro-evidence. These findings are independent of market (in)completeness, emphasising the importance of rational expectations. While market incompleteness and bounded rationality complement each other in attenuating the effects of forward guidance, we do not observe such a complementarity for the effectiveness of make-up strategies.

Suggested Citation

  • Dobrew, Michael & Gerke, Rafael & Giesen, Sebastian & Röttger, Joost, 2025. "Make-up strategies with incomplete markets and bounded rationality," European Economic Review, Elsevier, vol. 173(C).
    • Handle: RePEc:eee:eecrev:v:173:y:2025:i:c:s0014292124002708
    DOI: 10.1016/j.euroecorev.2024.104941
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    More about this item

    Keywords

    Make-up strategies; Incomplete markets; Bounded rationality; Effective lower bound; Average inflation targeting;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E70 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - General

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