Working Paper: NBER ID: w25363
Authors: Daron Acemoglu; Martin Kaae Jensen
Abstract: Rich behavioral biases, mistakes and limits on rational decision-making are often thought to make equilibrium analysis much more intractable. We show that this is not the case in the context of the neoclassical growth model (potentially incorporating incomplete markets and distortions). We break down the response of the economy to a change in the environment or policy into two parts: a direct response at a given vector of prices, and an equilibrium response that plays out as prices change. We refer to a change as a “local positive shock” if the direct response, when averaged across households, increases aggregate savings. Our main result shows that under weak regularity conditions, regardless of the details of behavioral preferences, mistakes and constraints on decision-making, the long-run equilibrium will involve a greater capital-labor ratio if and only if we start with a local positive shock. One implication of this result is that, from a qualitative point of view, behavioral biases matter for long-run equilibrium if and only if they change the direction of the direct response. We show that these aggregate predictions are coupled with individual-level “indeterminacy”: nothing much can be said about individual behavior.
Keywords: behavioral economics; neoclassical growth model; equilibrium analysis
JEL Codes: D50; D90; O41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| local positive shock (D59) | long-run capital-labor ratio (J24) |
| policy change (D78) | aggregate savings (E10) |
| initial direct response to policy change is positive (D78) | long-run capital stock must increase (E22) |
| behavioral biases (D91) | long-run equilibrium (D59) |
| local positive shock (D59) | aggregate effect remains positive (E10) |
| local negative shock (D59) | decreases in capital-labor ratios (J24) |