The Rationality Bias

We analyze differences in consumption and wealth in an estimated NewKeynesian model with rational and boundedly rational households. Shocksare shown to cause consumption and wealth heterogeneity due to the “rationality bias” of boundedly rational households. This bias can be decomposedinto three components, which, for certain specifications of monetary policy, can exactly offset each other. Moreover, a more hawkish response to infla-tion leads to more volatility in consumption and wealth heterogeneity, whichmakes it optimal for the central bank to set lower coefficients in the Taylorrule than would have been the case under homogeneous rational expectations.