IDEAS home Printed from https://ideas.repec.org/a/eee/jmacro/v60y2019icp60-78.html
   My bibliography  Save this article

Macroeconomic equilibrium and nominal price rigidities under imperfect rationality

Author

Listed:
  • Ciccarone, Giuseppe
  • Giuli, Francesco
  • Marchetti, Enrico

Abstract

We introduce some elements of Prospect Theory into a general equilibrium model with monopolistic competition and real wage rigidities due to wage bargaining, or efficiency wages. We show that an increase in workers’ loss aversion: (i) reduces the equilibrium wage and in this way increases potential output; (ii) induces workers to work/ consume less and in this way decreases potential output. Sharper loss aversion may hence increase or decrease potential output according to the relative strength of these two effects. We also show that if loss aversion reduces equilibrium output, it also enhances the effect of nominal price rigidities.

Suggested Citation

  • Ciccarone, Giuseppe & Giuli, Francesco & Marchetti, Enrico, 2019. "Macroeconomic equilibrium and nominal price rigidities under imperfect rationality," Journal of Macroeconomics, Elsevier, vol. 60(C), pages 60-78.
  • Handle: RePEc:eee:jmacro:v:60:y:2019:i:c:p:60-78
    DOI: 10.1016/j.jmacro.2019.01.008
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0164070416302063
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. George A. Akerlof & Janet L. Yellen, 1990. "The Fair Wage-Effort Hypothesis and Unemployment," The Quarterly Journal of Economics, Oxford University Press, vol. 105(2), pages 255-283.
    2. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 529-538.
    3. Barberis, Nicholas & Huang, Ming, 2009. "Preferences with frames: A new utility specification that allows for the framing of risks," Journal of Economic Dynamics and Control, Elsevier, vol. 33(8), pages 1555-1576, August.
    4. Ken Binmore & Ariel Rubinstein & Asher Wolinsky, 1986. "The Nash Bargaining Solution in Economic Modelling," RAND Journal of Economics, The RAND Corporation, vol. 17(2), pages 176-188, Summer.
    5. Eric Johnson & Simon Gaechter & Andreas Herrmann, 2006. "Exploring the Nature of Loss Aversion," Discussion Papers 2006-02, The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham.
    6. Botond Kőszegi & Matthew Rabin, 2006. "A Model of Reference-Dependent Preferences," The Quarterly Journal of Economics, Oxford University Press, vol. 121(4), pages 1133-1165.
    7. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    8. Jonathan Shalev, 2002. "Loss Aversion and Bargaining," Theory and Decision, Springer, vol. 52(3), pages 201-232, May.
    9. Kobayashi, Teruyoshi, 2003. "Multiplicative uncertainty in a model without inflationary bias," Economics Letters, Elsevier, vol. 80(3), pages 317-321, September.
    10. Laurence Ball & David Romer, 1990. "Real Rigidities and the Non-Neutrality of Money," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 183-203.
    11. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-666, September.
    12. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    13. Simon Gaechter & Eric Johnson & Andreas Herrmann, 2007. "Individual-Level Loss Aversion In Riskless And Risky Choices," Discussion Papers 2007-02, The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham.
    14. George A. Akerlof, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, Oxford University Press, vol. 97(4), pages 543-569.
    15. Santoro, Emiliano & Petrella, Ivan & Pfajfar, Damjan & Gaffeo, Edoardo, 2014. "Loss aversion and the asymmetric transmission of monetary policy," Journal of Monetary Economics, Elsevier, vol. 68(C), pages 19-36.
    16. Thomas Lustenberger & Enzo Rossi, 2017. "Does Central Bank Transparency and Communication Affect Financial and Macroeconomic Forecasts?," Working Papers 2017-12, Swiss National Bank.
    17. Ciccarone, Giuseppe & Marchetti, Enrico, 2009. "Revisiting the role of multiplicative uncertainty in a model without inflationary bias," Economics Letters, Elsevier, vol. 104(1), pages 37-39, July.
    18. Matthew Rabin, 2013. "An Approach to Incorporating Psychology into Economics," American Economic Review, American Economic Association, vol. 103(3), pages 617-622, May.
    19. Skott, Peter, 2005. "Fairness as a source of hysteresis in employment and relative wages," Journal of Economic Behavior & Organization, Elsevier, vol. 57(3), pages 305-331, July.
    20. Kfir Eliaz & Ran Spiegler, 2014. "Reference Dependence and Labor Market Fluctuations," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 159-200.
    21. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
    22. Ciccarone, Giuseppe & Marchetti, Enrico, 2013. "Rational expectations and loss aversion: Potential output and welfare implications," Journal of Economic Behavior & Organization, Elsevier, vol. 86(C), pages 24-36.
    23. George A. Akerlof, 2003. "Behavioral Macroeconomics and Macroeconomic Behavior," The American Economist, Sage Publications, vol. 47(1), pages 25-47, March.
    24. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    25. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard H, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1325-1348, December.
    26. Akerlof, George A & Yellen, Janet L, 1985. "Can Small Deviations from Rationality Make Significant Differences to Economic Equilibria?," American Economic Review, American Economic Association, vol. 75(4), pages 708-720, September.
    27. Ciccarone, Giuseppe & Giuli, Francesco & Marchetti, Enrico, 2013. "Power or loss aversion? Reinterpreting the bargaining weights in search and matching models," Economics Letters, Elsevier, vol. 118(2), pages 375-377.
    28. Thomas Lustenberger & Enzo Rossi, 2020. "Does Central Bank Transparency and Communication Affect Financial and Macroeconomic Forecasts?," International Journal of Central Banking, International Journal of Central Banking, vol. 16(2), pages 153-201, March.
    29. Anna Naszodi & Csaba Csavas & Daniel Felcser, 2016. "Which Aspects of Central Bank Transparency Matter? A Comprehensive Analysis of the Effect of Transparency of Survey Forecasts," International Journal of Central Banking, International Journal of Central Banking, vol. 12(4), pages 147-192, December.
    30. Nicholas Barberis & Ming Huang & Tano Santos, 2001. "Prospect Theory and Asset Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 116(1), pages 1-53.
    31. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
    32. Michaela Pagel, 2017. "Expectations-Based Reference-Dependent Life-Cycle Consumption," Review of Economic Studies, Oxford University Press, vol. 84(2), pages 885-934.
    33. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    34. Nicholas C. Barberis, 2013. "Thirty Years of Prospect Theory in Economics: A Review and Assessment," Journal of Economic Perspectives, American Economic Association, vol. 27(1), pages 173-196, Winter.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Prospect theory; Behavioral economics; Macroeconomic equilibrium;

    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jmacro:v:60:y:2019:i:c:p:60-78. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/622617 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.