Resolving New Keynesian Anomalies with Wealth in the Utility Function
Pascal Michaillat, Emmanuel Saez
July 2019
identifier / this version・arxiv:1905.13645v2
identifier / all versions・arxiv:1905.13645
July 2019
identifier / this version・arxiv:1905.13645v2
identifier / all versions・arxiv:1905.13645
abstract・At the zero lower bound, the New Keynesian model predicts that output and inflation collapse to implausibly low levels, and that government spending and forward guidance have implausibly large effects. To resolve these anomalies, we introduce wealth into the utility function; the justification is that wealth is a marker of social status, and people value social status. Since people save not only for future consumption but also to accrue social status, the Euler equation is modified. As a result, when the marginal utility of wealth is sufficiently large, the dynamical system representing the equilibrium at the zero lower bound transforms from a saddle to a source—which resolves all the anomalies.