Behavioral economics and macroeconomic models

• Insights from behavioral economics have led to progress in macroeconomics.
• Behavioral features can help with problems in the New Keynesian model.
• Important behavioral feature: fairness considerations for wages, employment.
• Behavioral features should be used in the design of savings plans, pension schemes.
• Further research needed to distinguish between behavioral & standard explanations.

Over the past 20 years, macroeconomists have incorporated more and more results from behavioral economics into their models. We argue that doing so has helped fixed deficiencies with standard approaches to modeling the economy—for example, the counterfactual absence of inertia in the standard New Keynesian model of economic fluctuations. We survey efforts to use behavioral economics to improve some of the underpinnings of the New Keynesian model—specifically, consumption, the formation of expectations and determination of wages and employment that underlie aggregate supply, and the possibility of multiple equilibria and asset price bubbles. We also discuss more broadly the advantages and disadvantages of using behavioral economics features in macroeconomic models.