Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/323614 
Year of Publication: 
2023
Citation: 
[Journal:] Journal of Financial Stability [ISSN:] 1878-0962 [Volume:] 67 [Article No.:] 101151 [Publisher:] Elsevier [Place:] Amsterdam [Year:] 2023 [Pages:] 1-25
Publisher: 
Elsevier, Amsterdam
Abstract: 
We develop a behavioral New Keynesian model to analyze optimal monetary policy with heterogeneously myopic households and firms. Five key results are derived. First, our model reflects coherent microeconomic and aggregate myopia due to the consistent transition from subjective to objective expectations. Second, the optimal monetary policy entails implementing inflation targeting in a framework where myopia distorts agents’ inflation expectations. Third, price level targeting emerges as the optimal policy under output gap, revenue, or interest rate myopia. Under price level targeting, rational inflation expectations are a minimal condition for optimality under bounded rationality. Fourth, bounded rationality is not necessarily welfare-decreasing and is even associated with welfare gains for extreme cognitive discounting. Finally, our empirical results point to the behavioral model’s superiority over the rational model.
Subjects: 
Behavioral macroeconomics
Central bank policy
Cognitive discounting
Heterogeneous expectations
Optimal simple rules
Monetary policy rule
Optimal policy
Behavioral economics
JEL: 
E37
E52
E58
E70
E7
G40
Published Version’s DOI: 
Document Type: 
Article
Document Version: 
Accepted Manuscript (Postprint)
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