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

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Farhi, Emmanuel

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w23281.Publication details: Cambridge, Mass. National Bureau of Economic Research 2017.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: 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.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w23281 (Browse shelf(Opens below))	Not For Loan

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March 2017.

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.