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@techreport{NBERw23281,
 title = "Monetary Policy, Bounded Rationality, and Incomplete Markets",
 author = "Farhi, Emmanuel and Werning, Iván",
 institution = "National Bureau of Economic Research",
 type = "Working Paper",
 series = "Working Paper Series",
 number = "23281",
 year = "2017",
 month = "March",
 doi = {10.3386/w23281},
 URL = "http://www.nber.org/papers/w23281",
 abstract = {This paper extends the benchmark New-Keynesian model by introducing two frictions: (1) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally binding borrowing constraints; and (2) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the <i>interaction</i> of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle”. Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model.},
}