Information, Attention, and Coordination in Macroeconomics

Massachusetts Institute Of Technology, Cambridge MA

Investigators

Abstract

Research demonstrates that individuals often do not behave in the way assumed in economic models. This award funds research that incorporates more realistic assumptions about individual and household behavior into macroeconomic modeling. Dr. Angeletos and his team will conduct several projects to understand the empirical, quantitative and policy relevance of this alternative approach to understanding macroeconomic outcomes. The research has transformative potential. The new model of economy-wide market efficiency assumes that individuals are boundedly rational (that is, they are sometimes inattentive or have limited cognitive abilities). The result promises to be new theories about the causes of business cycle fluctuations. These new results would be extremely useful for policy makers in many contexts, including the conduct of fiscal and monetary policy. The result would be a direct contribution to performance and competitiveness of the U.S. economy. The researcher will examine how frictions in information, attention, and cognition affect belief formation, coordination, and the overall outcomes that can be achieved in large economies. Specific contributions include: (1) A parsimonious structural interpretation of salient features of macroeconomic data. (2) A new formalization of the Keynesian multiplier widely used in macroeconomics that does not depend on unrealistic assumptions about nominal rigidity and policy constraints. This formalization may help to explain why aggregate demand shocks can trigger a recession. (3) A theory of why general equilibrium mechanisms may be less potent, or more slow-moving, than is usually presumed in macroeconomics. This theory can also explain the economy may respond to shocks and policy shifts as if the agents were discounting the future heavily. The new theory will be evaluated against empirical evidence. (4) New insights into the effects of monetary and fiscal policy during liquidity tramps, including a resolution to the forward-guidance puzzle and a rationale for front-loading fiscal stimuli. (5) Re-examining fiscal multipliers and Ricardian equivalence, along with a new approach to the equilibrium determinacy of the Neo-Keynesian model and the role of Taylor rules. (6) An investigation of the conditions under which the two fundamental welfare theorems do or do not extend to economies in which the agents are rationally inattentive or cognitively constrained. (7) Adaptation of lessons from the Ramsey policy paradigm and public finance to such economies. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.