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Behavioral Economics and Macroeconomic Models

  • Driscoll, John C.

    ()

    (Board of Governors of the Federal Reserve System (U.S.))

  • Holden, Steinar

    ()

    (University of Oslo)

Over the past 20 years, macroeconomists have incorporated more and more results from behavioral economics into their models. We argue that doing so has helped fixed deficiencies with standard approaches to modeling the economy--for example, the counterfactual absence of inertia in the standard New Keynesian model of economic fluctuations. We survey efforts to use behavioral economics to improve some of the underpinnings of the New Keynesian model--specifically, consumption, the formation of expectations and determination of wages and employment that underlie aggregate supply, and the possibility of multiple equilibria and asset price bubbles. We also discuss more broadly the advantages and disadvantages of using behavioral economics features in macroeconomic models.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2014-43.

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Length: 35 pages
Date of creation: 04 Jun 2014
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Handle: RePEc:fip:fedgfe:2014-43
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