A Business Cycle Model with Neuroeconomic Foundations

Abstract

Motivated by the consumer behavior literature, this paper presents a new business cycle model in which consumers incur a pain of paying and neglect the opportunity costs of consumption. The model has a unique equilibrium and can be easily solved in closed form. Although consumers maximize their utility and have perfect foresight, there is no Euler equation. Several New Keynesian puzzles disappear as a result: negative supply shocks do not stimulate the economy, lower interest rates are not deflationary, and forward guidance is not overly powerful.