This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

« Back to Results

Behavioral Macroeconomics

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Loews Philadelphia, Lescaze
Hosted By: Society for Economic Dynamics
  • Chair: Michael Woodford, Columbia University

Macroeconomic Policy Analysis When Planning Horizons are Finite

Michael Woodford
,
Columbia University

Abstract

The paper will argue for the desirability of a form of bounded rationality in which economic decision makers are not assumed to form complete state-contingent plans extending indefinitely into the future, but instead to only think forward a finite distance into the future. It will illustrate how this modification of the usual assumptions about the optimality of household and firm decisions changes the form of the structural equations of an otherwise standard New Keynesian model of the effects of monetary and fiscal policy, and will show that allowance for finite planning horizons provides a potential explanation for aspects of the data that have been embarrassing for NK models based on full rationality.
It will further show that while this assumption will still allow for many conclusions about the consequences of forward-looking behavior that are qualitatively (even if not quantitatively) the same as in standard analyses (in particular, precommitments of future policy can be valuable), it allows one to avoid paradoxical conclusions that are sometimes drawn from rational-expectations analysis in infinite-horizon models. It will discuss in particular the consequences of a more realistic assumption of limited forward planning for (i) the arguments of Cochrane and others for "neo-Fisherian" effects of commitments about future interest-rate policy, and (ii) debates about "the fiscal theory of the price level."

A Behavioral New Keynesian Model

Xavier Gabaix
,
Harvard University

Abstract

This paper presents a framework for analyzing how bounded rationality affects monetary and fiscal policy. The model is a tractable and parsimonious enrichment of the widely-used New Keynesian model – with one main new parameter, which quantifies how poorly agents understand future policy and its impact. That myopia parameter, in turn, affects the power of monetary and fiscal policy in a microfounded general equilibrium. A number of consequences emerge. (i) Fiscal stimulus or “helicopter drops of money” are powerful and, indeed, pull the economy out of the zero lower bound. More generally, the model allows for the joint analysis of optimal monetary and fiscal policy. (ii) The Taylor principle is strongly modified: even with passive monetary policy, equilibrium is determinate, whereas the traditional rational model yields multiple equilibria, which reduce its predictive power, and generates indeterminate economies at the zero lower bound (ZLB). (iii) The ZLB is much less costly than in the traditional model. (iv) The model helps solve the “forward guidance puzzle”: the fact that in the rational model, shocks to very distant rates have a very powerful impact on today’s consumption and inflation: because agents are partially myopic, this effect is muted. (v) Optimal policy changes qualitatively: the optimal commitment policy with rational agents demands “nominal GDP targeting”; this is not the case with behavioral firms, as the benefits of commitment are less strong with myopic firms. (vi) The model is “neo-Fisherian” in the long run, but Keynesian in the short run: a permanent rise in the interest rate decreases inflation in the short run but increases it in the long run. The non-standard behavioral features of the model seem warranted by the extant empirical evidence

Consumer Spending During Unemployment: Positive and Normative Implications

Peter Ganong
,
University of Chicago
Pascal Noel
,
University of Chicago

Abstract

We study the spending of unemployment insurance (UI) recipients using de-identified data from nearly 200,000 bank accounts. Spending on nondurables falls by 6% at the onset of unemployment, is largely stable during UI receipt, and then falls by an additional 13% at benefit exhaustion. Using cross-state variation, we show that spending responds to the level of UI benefits and drops exactly when UI benefits are exhausted. We explore the positive and normative implications of the drop in spending at UI exhaustion. From a positive perspective, our finding that spending responds to a large and predictable income drop sharpens an existing puzzle of the empirical excess sensitivity of spending to income, which is at odds with predictions from rational models. A model which includes hand-to-mouth consumers (Campbell and Mankiw 1989) as well as a model of inattentive consumers (Gabaix 2016) are able to generate a drop at exhaustion. In normative terms, because spending is so much lower after UI exhaustion than during UI receipt, the consumption-smoothing gains from extending UI benefits are at least three times as big as the gains from raising the level of UI benefits.

Strategic Inattention, Inflation Dynamics and the Non-neutrality of Money

Hassan Afrouzi
,
Columbia University

Abstract

In countries where inflation has been low and stable, price setters display highly dispersed aggregate inflation expectations; especially so when they face fewer competitors. In contrast to the predictions of standard models, realized inflation deviates significantly from price setters’ aggregate inflation expectations. Instead, their own-industry inflation expectations are more accurate, and aggregate inflation tracks these expectations closely. I propose a new dynamic model of rational inattention with oligopolistic competition to explain these stylized facts. The Phillips curve relates aggregate inflation to price setters’ own-industry inflation expectation, and firms forego learning about aggregate variables to focus on their own-industry prices. This incentive is stronger when every firm faces fewer competitors. Using new firm-level survey evidence, I calibrate the degree of rational inattention and industry size in the model and find that a two-fold increase in the number of competitors reduces the half-life and on-impact response of output to a monetary policy shock by 40 and 15 percent, respectively.
JEL Classifications
  • E0 - General
  • D7 - Analysis of Collective Decision-Making