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Over the past 20 years, macroeconomists have incorporated more and more results from behavioral economics into their models. We argue that doing so has helped fixed deficiencies with standard approaches to modeling the economy-for example, the counterfactual absence of inertia in the standard New Keynesian model of economic fluctuations. We survey efforts to use behavioral economics to improve some of the underpinnings of the New Keynesian model-specifically, consumption, the formation of expectations and determination of wages and employment that underlie aggregate supply, and the possibility of multiple equilibria and asset price bubbles. We also discuss more broadly the advantages and disadvantages of using behavioral economics features in macroeconomic models.

In an important paper, Fuhrer and Moore (1995) showed that Taylor (1980)'s staggered wage setting model does not exhibit persistence in inflation; they proposed a simple modification, in which workers cared about the real wages of other workers, which solves this problem. However, we argue that the key part of Fuhrer and Moore's model is not that workers care about the real wages of other workers, but that workers are assumed to care about the past real wages of other workers. When that assumption is replaced by the assumption that workers care about current real wages of other workers, the Fuhrer and Moore model reverts identically to the Taylor model. We also show that a simple model in which workers care about their own past real wages, e.g. because unemployment insurance depends on past wages, as noted in Blanchard and Katz (1999), generates negative autocorrelations in inflation.