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Temptation and forward-guidance

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  • Airaudo, Marco

Abstract

Motivated by the extensive experimental and empirical evidence on preference reversal in consumption choices, we introduce temptation with self-control preferences into a New Keynesian model to study the effects of forward guidance in monetary policy, and the related forward guidance puzzle. In our set-up, the representative agent faces a trade off between the temptation for immediate satisfaction (liquidate wealth) with his long-run best (smooth consumption), which he manages by exerting cognitive effort (or self-control). For higher risk aversion in temptation than in commitment utility, there is discounting in the linearized Euler equation. The latter makes the response of current real activity to the announcement of a future policy change declining in the forward guidance horizon, which then helps solving the puzzle. Our framework delivers testable aggregate and policy implications that distinguish it from alternative microfoundations for discounting in the Euler equation previously used to solve the puzzle.

Suggested Citation

  • Airaudo, Marco, 2020. "Temptation and forward-guidance," Journal of Economic Theory, Elsevier, vol. 186(C).
    • Handle: RePEc:eee:jetheo:v:186:y:2020:i:c:s0022053118303569
    DOI: 10.1016/j.jet.2019.104989
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    2. Meggiorini, Greta, 2023. "Behavioral New Keynesian Models: An empirical assessment," Journal of Macroeconomics, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    Monetary policy; New Keynesian model; Forward guidance; Temptation; Self-control;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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