Monetary Policy, Bounded Rationality, and Incomplete Markets / Emmanuel Farhi, Iván Werning.

Format:

Book

Author/Creator:

Farhi, Emmanuel.

Contributor:

National Bureau of Economic Research.

Werning, Iván.

Series:

Working Paper Series (National Bureau of Economic Research) no. w23281.

NBER working paper series no. w23281

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2017.

Summary:

This paper extends the benchmark New-Keynesian model by introducing two 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 <i>interaction</i> of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is 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.

Notes:

Print version record

March 2017.