This paper studies the empirical fit of a standard dynamic stochastic general equilibrium (DSGE) model to US macroeconomic data altered by a bounded rationality assumption in agents’ expectation formation. Bounded rationality is in the form of cognitive discounting, or “myopia", which quantifies how people pay less attention to events occurring further in the future. I use a Bayesian likelihood approach to compare the distribution of model parameters for when people are fully rational (i.e. rational expectations) and for when they are myopic. The behavioral model finds evidence of mild myopia in the US economy between 1966 and 2004 evidenced by a general decrease of posterior parameter distributions. However, the marginal likelihood criterion is modestly higher without myopia and thereby implies a better fit. The decrease in posterior distributions shows that the model is sensitive to expectations formations while the marginal like- lihood suggests that myopic behavior can be modeled differently to match the data.
This paper was previously circulated as "DSGE Modeling with Cognitive Discounting".
