A New Keynesian Model with Wealth in the Utility Function
abstract: The New Keynesian model suffers from several anomalies at the zero lower bound: explosive paths of output and inflation, forward-guidance puzzle, and so on. To resolve these anomalies, we introduce relative wealth into households' utility function; the justification is that relative wealth is a marker of social status, and people value high social status. Since people save not only for future consumption but also to accrue social status, the Euler equation is modified. Thus, when the marginal utility of wealth is sufficiently large, the dynamical system representing the equilibrium at the zero lower bound becomes a source instead of a saddle, which resolves all the anomalies.