By Pascal Michaillat and Emmanuel Saez
This paper extends the New Keynesian model by introducing wealth, in the form of government bonds, into the utility function. The extension modifies the Euler equation: in steady state the real interest rate is negatively related to consumption instead of being constant, equal to the time discount rate. Thus, when the marginal utility of wealth is large enough, the dynamical system representing the equilibrium is a source not only in normal times but also at the zero lower bound. This property eliminates the zero-lower-bound anomalies of the New Keynesian model, such as explosive output and inflation, and forward-guidance puzzle.
I have to confess that I have a hard time with the innovative assumption of this paper. Do people really really care about their wealth beyond what it brings in terms of future consumption? OK, wealth brings status, but does this matter this much? And is this status wealth in government bonds? I would have thought that to rather be in oversized housed, expensive cars and golden toilets.