Template-Type: ReDIF-Paper 1.0 
Title: Monetary and fiscal policy in a two-country model with behavioral expectations
Author-Name: Michał Brzoza-Brzezina 
Author-Name: Paweł Galiński 
Author-Name: Makarski Krzysztof 
Abstract: We check how monetary and fiscal policies (in particular their open-economy dimensions) are affected by expectations being behavioral in the spirit of Gabaix (2020). We first show that the data strongly favor this setting compared with the standard rational  expectations (RE) assumption. Then we document several novel findings. First, monetary policy is less powerful and faces a higher sacrifice ratio when agents are behavioral. Second, the Taylor principle is affected: determinacy regions are larger if the economy is more open or the central bank abroad is more hawkish. Third, fiscal policy and its international spillovers are amplified under behavioral expectations (BE). In contrast, the spillovers of monetary policy are dampened. Fourth, BE contribute to solving the puzzle of excess foreign currency returns (UIP puzzle).
Number: 2025-110
Length: 47 pages 
Creation-Date: 2025-03
Keywords: behavioral agents, monetary and fiscal policy, open-economy model
Classification-JEL: E30, E43, E52, E70
File-URL: https://hdl.handle.net/20.500.12182/1330
File-Format: Application/pdf
DOI: 10.33119/kaewps2025110
Handle: RePEc:sgh:kaewps:2025110