A Behavioral New Keynesian Model

Gabaix, Xavier

doi:10.3386/w22954

Cited by 87 publications

(110 citation statements)

References 22 publications

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“…Our work also shows that the empirical impact of purely Odyssean shocks on output and prices is not excessively strong. This is consistent with recent models in which the impact of forward guidance is mitigated compared with its impact in the basic New Keynesian setup due to incomplete markets (McKay, Nakamura and Steinsson 2016), imperfect information and higher-order beliefs (Angeletos and Lian 2018), bounded rationality (Gabaix 2016), or bounded rationality combined with incomplete markets (Farhi and Werning forthcoming).…”

Section: Related Literaturesupporting

confidence: 88%

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Andrade

Ferroni

2019

Federal Reserve Bank of Boston Research Department Working Papers

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What drives the strong reaction of financial markets to central bank communication on the days of policy decisions? We highlight the role of two factors that we identify from highfrequency monetary surprises: news on future macroeconomic conditions (Delphic shocks) and news on future monetary policy shocks (Odyssean shocks). These two shocks move the yield curve in the same direction but have opposite effects on financial conditions and macroeconomic expectations. A drop in future interest rates that is associated with a negative Delphic (Odyssean) shock is perceived as being contractionary (expansionary). These offsetting effects can explain why central bank communication leads to a strong reaction of the yield curve together with a weak reaction by inflation expectations or stock prices. The two shocks also have different impacts on macroeconomic outcomes, such that central bankers cannot infer the degree of stimulus they provide by looking at the mere reaction of the yield curve. However, changes in their communication policy can influence the way markets predominantly understand communication about future interest rates. JEL Classifications: E52, E32, C10

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Section: Related Literaturesupporting

confidence: 88%

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Andrade

Ferroni

2019

Federal Reserve Bank of Boston Research Department Working Papers

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“…The first is the cost of monitoring portfolio allocations, which can cause investors to only infrequently pay attention to their portfolios. The second explanation is that even after paying attention to their portfolios, a number of additional costs may prevent investors from trading; these can include physical transaction costs coming from brokerage commissions and capital gains taxes (see above), and mental costs coming from the need to determine optimal behavior based on beliefs and current portfolios (see Gabaix, 2016).…”

Section: Infrequent Tradingmentioning

confidence: 99%

Five Facts About Beliefs and Portfolios

et al. 2019

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We administer a newly-designed survey to a large panel of retail investors who have substantial wealth invested in financial markets. The survey elicits beliefs that are crucial for macroeconomics and finance, and matches respondents with administrative data on their portfolio composition and their trading activity. We establish five facts in this data: (1) Beliefs are reflected in portfolio allocations. The sensitivity of portfolios to beliefs is small on average, but varies significantly with investor wealth, attention, trading frequency, and confidence. (2) It is hard to predict when investors trade, but conditional on trading, belief changes affect both the direction and the magnitude of trades.(3) Beliefs are mostly characterized by large and persistent individual heterogeneity; demographic characteristics explain only a small part of why some individuals are optimistic and some are pessimistic. (4) Investors who expect higher cash flow growth also expect higher returns and lower long-term price-dividend ratios. (5) Expected returns and the subjective probability of rare disasters are negatively related, both within and across investors. These five facts challenge the rational expectation framework for macro-finance, and provide important guidance for the design of behavioral models. AbstractWe administer a newly-designed survey to a large panel of retail investors who have substantial wealth invested in financial markets. The survey elicits beliefs that are crucial for macroeconomics and finance, and matches respondents with administrative data on their portfolio composition and their trading activity. We establish five facts in this data: (1) Beliefs are reflected in portfolio allocations. The sensitivity of portfolios to beliefs is small on average, but varies significantly with investor wealth, attention, trading frequency, and confidence. (2) It is hard to predict when investors trade, but conditional on trading, belief changes affect both the direction and the magnitude of trades. (3) Beliefs are mostly characterized by large and persistent individual heterogeneity; demographic characteristics explain only a small part of why some individuals are optimistic and some are pessimistic. (4) Investors who expect higher cash flow growth also expect higher returns and lower long-term price-dividend ratios. (5) Expected returns and the subjective probability of rare disasters are negatively related, both within and across investors. These five facts challenge the rational expectation framework for macro-finance, and provide important guidance for the design of behavioral models. JEL Codes: G11, G12, R30.

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“…If the private sector was less forward-looking than standard models assume, e.g. due to "bounded rationality", promises about keeping the interest rate low in the future would have less of an effect on price setting, demand and output today (Gabaix (2016)). Also, the promise needs to be credible.…”

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confidence: 99%

Communication of Monetary Policy in Unconventional Times

et al. 2017

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Monetary policy communication is particularly important during unconventional times, because high uncertainty about the economy, the introduction of new policy tools and possible limits to the central bank's toolkit could hamper the predictability of policy actions. We study how monetary policy communication should and has worked under such circumstances. Our main results relate to announcements of asset purchase programmes and the use of forward guidance. We show that announcements of asset purchase programmes have lowered market uncertainty, particularly when accompanied by a contextual release of implementation details such as the envisaged size of the programme. We also show that forward guidance reduces uncertainty more effectively when it is state-contingent or when it provides guidance about a long horizon than when it is open-ended or covers only a short horizon, and that the credibility of forward guidance is strengthened if the central bank also has embarked on an asset purchase programme. Non-technical summaryCommunication can help making central banks transparent and thereby contribute to their accountability and to the management of expectations of economic agents. While these roles are generally important, they become even more relevant in unconventional times, when central banks need to explain the rationale and the workings of the various new policy tools that they employ, when the public will want to understand how the central bank will use the new tools, and how the central bank will eventually want to exit from using these tools. Managing expectations of economic agents about the future course of monetary policy is therefore essential in such circumstances, also because under a situation of elevated uncertainty, the central bank should strive to minimize any uncertainty about its own behaviour, to the extent possible.Looking back at several years of experience with unconventional monetary policies in several economies, this paper provides an assessment of the effects and effectiveness of central bank communication during unconventional times. The focus of the paper is on the role of clarity in central bank communication, both when it comes to announcing new policy tools and when using forward guidance. The paper shows that communication about new policy tools reduces market uncertainty in particular when the announcements provide information about the envisaged size of a programme. With regard to forward guidance, clarity can be achieved by stressing the statedependency of the central bank's reaction function. In line with this reasoning, the paper shows that forward guidance is more effective in managing expectations when it is state-contingent or when it provides guidance about a long horizon than when it is open-ended or covers only a short horizon. In addition, the credibility of forward guidance seems to be considerably enhanced if the central bank simultaneously has an asset purchase programme in place.The findings of this paper have implications for monetary policy communicatio...

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A Behavioral New Keynesian Model

Cited by 87 publications

References 22 publications

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Delphic and Odyssean Monetary Policy Shocks: Evidence from the Euro Area

Five Facts About Beliefs and Portfolios

Communication of Monetary Policy in Unconventional Times

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