Human Frictions to the Transmission of Economic Policy

The consumption Euler equation is at the heart of modern dynamic macroeconomic models but a recent literature argues that accounting for heterogeneity in uninsurable income shocks, financial constraints, and the positions in the wealth distribution might be important for the transmission of fiscal and monetary policy. We document empirically another important heterogeneity for the effectiveness of policy: cognitive abilities. Men who score high on standardized IQ tests have absolute forecast errors for inflation which are smaller by a factor of 2 relative to other men in a representative sample of Finnish households. Crucially, only men with high IQ increase their consumption propensities when they think inflation will rise and are twice as sensitive in their propensity to take out loans to changes in interest rates. Our findings suggest another impediment besides financial and other constraints to the transmission of common monetary and fiscal policies: human frictions.