We conduct a laboratory experiment to shed light on the cognitive limitations that may affect the way decision makers respond to changes in their economic environment. The subjects solve a tracking problem: they estimate the probability of a binary event, which changes stochastically. The...

The theory of expected utility maximization (EUM) proposed by Bernoulli explains risk aversion as a consequence of diminishing marginal utility of wealth. However, observed choices between risky lotteries are difficult to reconcile with EUM: for example, in the laboratory, subjects’ responses...

We propose a model of optimal decision making subject to a memory constraint. The constraint is a limit on the complexity of memory measured using Shannon’s mutual information, as in models of rational inattention; but our theory differs from that of Sims (2003) in not assuming costless...

In an experiment that elicits subjects' willingness to pay (WTP) for the outcome of a lottery, we confirm the fourfold pattern of risk attitudes described by Kahneman and Tversky. In addition, we document a systematic effect of stake sizes on the magnitude and sign of the relative risk premium,...

Dani Rodrik (2008) offers a provocative argument for policies that seek to maintain an "undervalued" exchange rate in order to promote economic growth. The key to his argument is the empirical evidence that he presents, indicating correlation of his measure of undervaluation with economic growth...

I present a generalization of the standard (full-information) model of state- dependent pricing in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market con- ditions. The imperfect information is endogenized using a...

We consider the desirability of modifying a standard Taylor rule for a cen- tral bank's interest-rate policy to incorporate either an adjustment for changes in interest-rate spreads (as proposed by Taylor, 2008, and by McCulley and Toloui, 2008) or a response to variations in the aggregate...

This paper considers a general class of nonlinear rational-expectations models in which policymakers seek to maximize an objective function that may be household expected utility. We show how to derive a target criterion that is: (i) consistent with the model's structural equations, (ii) strong...

This paper explains the key factors that determine the effectiveness of government purchases as a means of increasing output and employment in New Keynesian models, through a series of simple examples that can be solved analytically. Delays in the adjustment of prices or wages can allow for...

While many analyses of monetary policy consider only a target for a short-term nominal interest rate, other dimensions of policy have recently been of greater importance: changes in the supply of bank reserves, changes in the assets acquired by central banks, and changes in the interest rate...