🤖 AI Summary
Standard macroeconomic models struggle to account for the sluggish response of consumption to policy shocks, often resorting to exogenous frictions such as habit formation. This paper proposes an endogenous theory of macroeconomic inertia by embedding survey-based expectations on income and interest rates—instead of rational expectations—into a heterogeneous-agent general equilibrium framework that combines Blanchard’s perpetual youth structure with Bewley’s incomplete markets. An unobserved components model of expectations is incorporated to capture extrapolative biases. The approach successfully replicates consumption inertia and demonstrates that policy designs weakening expectation anchoring—such as gradualist monetary policy or delayed fiscal financing—substantially prolong transmission lags, thereby offering a novel microfoundation for macroeconomic inertia and new implications for policy design.
📝 Abstract
Benchmark macroeconomic models require additional frictions to explain the sluggish response of aggregate variables to sudden shocks or changes in policy. I show that standard heterogeneous agent (HA) models, the Blanchard (1985) perpetual youth and Bewley (1986) incomplete markets models, are consistent with aggregate consumption inertia without the use of habit preferences or any specific model of expectation underreaction to dampen the responsiveness of consumption savings decisions. I instead replicate observed consumption inertia in standard HA models by directly substituting survey expectations of income and interest rates for agents' expectations. I propose a new theory of macroeconomic inertia that rationalizes the observed extrapolation bias in survey expectations by embedding an unobserved components model of expectations into a tractable HA general equilibrium environment. Inertia results when expectations imperfectly account for the equilibrium amplification of shocks, which is large in HA economies. This imperfect inference causes expectations to gradually unanchor as agents repeatedly misattribute large responses of equilibrium outcomes simply to larger shocks. This theory also illustrates a novel drawback to inertial monetary policy rules and the delayed financing of fiscal deficits: Policy regimes that act more gradually experience longer transmission lags due to their decreased effectiveness at anchoring expectations.