Fiscal Policy Perceptions in a Behavioral New Keynesian Model

We study misperceptions of scal policy in a New Keynesian model based on the imperfect cognition framework of Gabaix (2020), where agents have limited ability to forecast future macroeconomic variables. We derive three main insights. First, we document the failure of Ricardian equivalence under misperception as the main transmission channel of shocks. Second, monetary policy has a weakened impact on macroeconomic variables when compared with the full information case. Third, we propose an endogenization of the cognitive parameters as an extension to Gabaix (2020). Robustness analysis reveals how households' cognitive ability plays a dominant role in affecting the size of macroeconomic fluctuations.