Monetary Policy, Bounded Rationality, and Incomplete Markets
This paper extends the benchmark New-Keynesian model with a representative agent and rational expectations by introducing two key frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is much more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model. We conclude that the interaction of bounded rationality and market frictions improves the ability of the model to account for the effects of monetary policy.
|Date of creation:||Mar 2017|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Oh, Hyunseung & Reis, Ricardo, 2012.
"Targeted transfers and the fiscal response to the great recession,"
Journal of Monetary Economics,
Elsevier, vol. 59(S), pages 50-64.
- Hyunseung Oh & Ricardo Reis, 2011. "Targeted Transfers and the Fiscal Response to the Great Recession," NBER Working Papers 16775, National Bureau of Economic Research, Inc.
- Oh, Hyunseung & Reis, Ricardo, 2011. "Targeted transfers and the fiscal response to the great recession," CEPR Discussion Papers 8239, C.E.P.R. Discussion Papers.
- Greg Kaplan & Giovanni L. Violante, 2014. "A Model of the Consumption Response to Fiscal Stimulus Payments," Econometrica, Econometric Society, vol. 82(4), pages 1199-1239, 07.
- Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:23281. 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: ()
If references are entirely missing, you can add them using this form.