Seminar 218, Psychology and Economics: Present Bias Amplifies the Household Balance-Sheet Channels of Macroeconomic Policy (Online)

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Submitted by Brandon Eltiste on January 08, 2021
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Monday, March 29, 2021 - 10:00
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Peter Maxted, Harvard University

ABSTRACT: We study the effect of monetary and fiscal policy in a heterogeneous-agent model where households have present-biased time preferences and naive beliefs. The model features a liquid asset and illiquid home equity, which households can use as collateral for borrowing. Because present bias substantially increases households’ marginal propensity to consume (MPC), present bias increases the impact of fiscal policy. Present bias also amplifies the effect of monetary policy but, at the same time, slows down the speed of monetary transmission. Interest rate cuts incentivize households to conduct cash-out refinances, which become targeted liquidity-injections to high-MPC households. But present bias also introduces a motive for households to procrastinate refinancing their mortgages, which slows down the speed with which this monetary channel operates.