Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/268488 
Year of Publication: 
2023
Series/Report no.: 
Deutsche Bundesbank Discussion Paper No. 01/2023
Publisher: 
Deutsche Bundesbank, Frankfurt a. M.
Abstract: 
We study the impact of market incompleteness and bounded rationality on the effectiveness of make-up strategies. To do so, we simulate a heterogeneous-agent New Keynesian (HANK) model with reflective expectations and an occasionally-binding effective lower bound (ELB) on the policy rate. Our simulations show that make-up strategies can mitigate the negative consequences of the ELB for inflation and real economic activity. This result holds both for our HANK model as well as a corresponding representative-agent (RANK) model with complete markets, suggesting that market (in)completeness is not important for the effectiveness of make-up strategies. However, the stabilisation benefits of make-up strategies are small when agents' cognitive ability is consistent with micro-evidence. This result is independent of market (in)completeness, emphasising the importance of rational expectations for make-up strategies. Furthermore, while market incompleteness and bounded rationality complement each other in attenuating the effects of forward guidance in our model, we do not observe such a complementarity with respect to the benefits of make-up strategies.
Subjects: 
Make-Up Strategies
Incomplete Markets
Bounded Rationality
HANK
Effective Lower Bound
Average Inflation Targeting
JEL: 
C63
D31
E21
E31
E52
E58
E70
ISBN: 
978-3-95729-932-1
Document Type: 
Working Paper

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