DP16141 Short-term Planning, Monetary Policy, and Macroeconomic Persistence

Author(s): Christopher Gust, Edward Herbst, J David López-Salido
Publication Date: May 2021
Keyword(s): Bayesian estimation, Finite-horizon planning, learning, monetary policy, New Keynesian Model
JEL(s): C11, E52, E70
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16141

This paper estimates a behavioral New Keynesian (NK) model in which households and firms plan over a finite horizon. The finite-horizon (FH) model outperforms rational expectations versions of the NK model as well as other behavioral NK models. In the FH model, households and firms are forward-looking in thinking about events over their planning horizon but are backward looking regarding events beyond that point. This gives rise to substantial aggregate persistence without resorting to additional features such as habit persistence and price contracts indexed to lagged inflation.