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Interest Rate Rules And Equilibrium Stability Under Deep Habits

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  • Zubairy, Sarah

Abstract

This paper studies the determinacy of equilibrium in a new Keynesian model with deep habits under different interest rate rules. The main finding is that an interest rate rule satisfying the Taylor principle is no longer a sufficient condition to guarantee determinacy. Including interest rate smoothing and a response to output deviations from steady state significantly enlarges the regions of determinacy. However, under all the simple interest rate rules considered, determinacy is not guaranteed for a very high degree of deep habits. Deep habits give rise to countercyclical markups, which is in line with empirical evidence and makes them an appealing feature in the study of demand shocks. The countercyclicality of markups also leads to multiple equilibria because of self-fulfilling expectations for a high degree of deep habit formation.

Suggested Citation

  • Zubairy, Sarah, 2014. "Interest Rate Rules And Equilibrium Stability Under Deep Habits," Macroeconomic Dynamics, Cambridge University Press, vol. 18(1), pages 23-40, January.
    • Handle: RePEc:cup:macdyn:v:18:y:2014:i:01:p:23-40_00
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    Cited by:

    1. McKnight, Stephen, 2017. "Are Consumption Taxes Preferable To Income Taxes For Preventing Macroeconomic Instability?," Macroeconomic Dynamics, Cambridge University Press, vol. 21(4), pages 1023-1058, June.
    2. Airaudo, Marco & Olivero, María Pía, 2014. "Optimal Monetary Policy with Counter-Cyclical Credit Spreads," School of Economics Working Paper Series 2014-1, LeBow College of Business, Drexel University.
    3. Rui Faustino, 2019. "Deep Habits in New Keynesian model with durable goods," Working Papers REM 2019/0106, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    4. Givens, Gregory E., 2016. "On the gains from monetary policy commitment under deep habits," Journal of Macroeconomics, Elsevier, vol. 50(C), pages 19-36.
    5. Marco Riguzzi & Philipp Wegmueller, 2017. "Economic Openness and Fiscal Multipliers," International Economic Journal, Taylor & Francis Journals, vol. 31(1), pages 1-35, January.
    6. Jacob, Punnoose & Uusküla, Lenno, 2019. "Deep habits and exchange rate pass-through," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 67-89.
    7. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Bank of Finland Research Discussion Papers 5/2020, Bank of Finland.
    8. repec:zbw:bofrdp:2020_005 is not listed on IDEAS
    9. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Research Discussion Papers 5/2020, Bank of Finland.
    10. Ambrocio, Gene, 2023. "Demographic aging and the New Keynesian Phillips Curve," Bank of Finland Research Discussion Papers 16/2023, Bank of Finland.

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