"This project aims at providing novel foundations for the aggregate supply and demand blocks of current macro models, which are extensively used for policy evaluation. On the aggregate-supply side, the first part of the proposal is motivated by recent extensive and consistent empirical evidence on the presence of downward nominal and real rigidities in developed economies. The objective is to investigate the theoretical and empirical implications of including these rigidities in current macro models for: 1) the long-run relationships between inflation, unemployment and productivity growth; 2) the joint dynamics of inflation and unemployment; 3) the role of macroeconomic volatility in influencing these relationships; 4) the distribution of wages. From the policy perspective, several key implications would be examined in terms of the optimal inflation rate and the appropriate degree of stabilization policies. The second part of the proposal deals with the aggregate-demand side of current models and particularly with the specification of the stochastic discount factor. It is a well-known fact that macro models are unable to match the asset-price implications of the data. These shortcomings are more pronounced in open-economy models since the stochastic discount factors also determine the cross-country distribution of wealth and the portfolio allocations. The project will: 1) document the failures of standard preferences in accounting for several puzzles; 2) study whether there exists some stochastic discount factor that can be consistent with the data and with no-arbitrage theories; 3) add a macro structure on this stochastic discount factor while maintaining its consistency with data. In reference to the latter point, particular attention will be devoted to near-rational theories of optimizing behaviour in which the distortions in the subjective probability distributions can be related to macro variables through an optimizing model.Finally, the research under this proposal will integrate the findings of part 1) and part 2) of the project to propose more realistic frameworks in which it is possible to investigate how investment and consumption decisions change when agents’ evaluation of future contingencies is distorted or uncertain. In particular, the project aims at investigating how monetary policy should be set when agents fear model misspecification, which manifests itself thorugh considerable and realistic premia in holding risky assets."