UC Irvine

Several years ago, Robert Lucas’s critique of non-structural models led to the rational expectations revolution in macroeconomics, pioneering several so-called DSGE models of the economic business cycle. While these serve as an appropriate lens through which we could view the economy, the picture these models capture is nonetheless blurry. In these essays, I attempt to correct for a fundamental oversight in some of these models by allowing agents to deviate from perfect rationality so as to better capture human behavior. The first two essays model investors as imperfectly rational, exhibiting cognitive biases such as anchoring and confidence swings that occur both endogenously and exogenously. The results show that business cycles are more volatile when financial agents are behavioral and that such biases can explain a host of historic phenomenon such as the 2008 financial crisis. In the third essay, we explore the effects of cognitive discounting on fiscal multipliers. We show that Ricardian equivalence is further violated when agents are myopic but that such effects are non-linear. Myopia also interacts with monetary inflation targeting and the share of hand-to-mouth agents to have severe effects on the determinacy conditions of the model. All these intricacies are lost when looking purely through a rational expectations lens.