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Resolving New Keynesian Anomalies with Wealth in the Utility Function

Pascal Michaillat¹; Emmanuel Saez²

¹ Brown University · ² University of California, Berkeley

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 status. Since people partly save 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 zero-lower-bound equilibrium transforms from a saddle to a source, which resolves all the anomalies.

DOI

10.1162/rest_a_00893

Volume

103 (2)

Pages

197-215

Language

en

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