We develop a novel bounded rationality model of imperfect reasoning as the interaction between automatic (System 1) and analytical (System 2) thinking. In doing so, we formalize the empirical consensus of cognitive psychology using a structural, constrained-optimal economic framework of mental information acquisition about the unknown optimal policy function. A key result is that agents reason less (more) when facing usual (unusual) states of the world, producing state- and history-dependent behavior. Our application is an otherwise standard incomplete-markets model with no a priori behavioral biases. The ergodic distribution of actions and beliefs is characterized by endogenous learning traps, where locally stable state dynamics generate familiar regions of the state space within which behavior appears to follow memory-based heuristics. This results in endogenous behavioral biases that have many empirically desirable properties: the marginal propensity to consume is high even for unconstrained agents, hand-to-mouth status is more frequent and persistent, and there is more wealth inequality than in the standard model.

We propose a model in which the emergence of a single dominant currency is driven by the need to finance international trade. The model generates multiple stable steady states, each characterized by a different dominant asset, consistent with the historical durability of real-world currency regimes. The persistence of regimes is caused by a positive interaction between the returns to saving in an asset and the use of that asset for financing trade. A calibrated version of the model shows that the welfare gains of dominance are substantial, but accrue primarily during the transition to dominance. We perform several counterfactual experiments to assess potential threats to the dollar’s continued dominance.

We propose a new theory of price rigidity based on firms' Knightian uncertainty about their competitive environment. This uncertainty has two key implications. First, firms learn about the shape of their demand function from past observations of quantities sold. This learning gives rise to kinks in the expected profit function at previously observed prices, making those prices both sticky and more likely to reoccur. Second, uncertainty about the relationship between aggregate and industry‐level inflation generates nominal rigidity. We prove the main insights analytically and quantify the effects of our mechanism. Our estimated quantitative model is consistent with a wide range of micro‐level pricing facts that are typically challenging to match jointly. It also implies significantly more persistent monetary non‐neutrality than in standard models, allowing it to generate large real effects from nominal shocks.

We show that international portfolios reflect the underlying heterogeneity in investors’ beliefs. Using data on the foreign sovereign debt holdings of European banks matched with their forecasts on future bond yields, we find that expecting higher returns and having more accurate forecasts are associated with larger bond holdings. Crucially, the elasticity of portfolio holdings to expected returns is increasing in the precision of the forecast, implying that investors optimally exploit comparative advantages in information production. We rationalize the results in a model in which partial information specialization arises endogenously by introducing a degree of unlearnable uncertainty about asset payoffs.