Temptation-driven preferences: A resolution to New Keynesian anomalies

Abstract

For empirically plausible calibrations, the New Keynesian model delivers several anomalous results: positive correlation between inflation and nominal rates, higher output volatility with more flexible prices, low government spending multipliers, and unreasonably large responses at the zero-lower-bound, . The introduction of behavioral consumers characterized by Gul–Pesendorfer’s temptation-with-self-control preferences – a well-documented feature of experimental/field evidence on individual choices under risk and over time – resolves the anomalies while retaining the elegance and analytical tractability of the baseline 3-equation framework.