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Keeping up with the Joneses and the welfare effects of monetary policy

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  • Tervala, Juha

Abstract

This paper examines the implications of “keeping up with the Joneses” preferences (jealousy) for the welfare effects of monetary policy. I develop a New Keynesian model, where households are jealous and the central bank follows the Taylor rule. I show that the welfare effects of monetary policy over time depend significantly on the relative strength of the consumption externality caused by jealousy and the monopolistic distortion. When a first-order approximation of the utility function is used, then the main result is the following: If jealousy (the monopolistic distortion) dominates, then a decrease in the interest rate reduces (increases) welfare in the short run, but increases (reduces) welfare in the medium run. However, the use of a second-order approximation changes the sign of the overall welfare effect of monetary policy if the initial level of employment is at the optimal level or just below it.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Psychology.

Volume (Year): 33 (2012)
Issue (Month): 1 ()
Pages: 104-111

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Handle: RePEc:eee:joepsy:v:33:y:2012:i:1:p:104-111

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Web page: http://www.elsevier.com/locate/joep

Related research

Keywords: Monetary policy; Jealousy; Consumption externality;

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  1. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  2. Christian Pierdzioch & Serkan Yener, 2004. "On the Welfare Effects of Monetary Policy When Households Try to Keep Up with the Rest of the World," Kiel Working Papers 1198, Kiel Institute for the World Economy.
  3. Amato, Jeffery D. & Laubach, Thomas, 2004. "Implications of habit formation for optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 305-325, March.
  4. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  5. Howarth, Richard B., 2006. "Optimal environmental taxes under relative consumption effects," Ecological Economics, Elsevier, vol. 58(1), pages 209-219, June.
  6. Ireland, N. J., 2001. "Optimal income tax in the presence of status effects," Journal of Public Economics, Elsevier, vol. 81(2), pages 193-212, August.
  7. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  8. Sanjay K. Chugh, 2004. "Does monetary policy keep up with the Joneses? Optimal interest-rate smoothing with consumption externalities," International Finance Discussion Papers 812, Board of Governors of the Federal Reserve System (U.S.).
  9. Christian Pierdzioch, 2003. "Keeping Up with the Joneses: Implications for the Welfare Effects of Monetary Policy in Open Economies," Kiel Working Papers 1166, Kiel Institute for the World Economy.
  10. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  11. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
  12. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  13. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
  14. Andrew B. Abel, 2005. "Optimal Taxation when Consumers Have Endogenous Benchmark Levels of Consumption," Review of Economic Studies, Oxford University Press, vol. 72(1), pages 21-42.
  15. Bill Dupor & Wen-Fang Liu, 2003. "Jealousy and Equilibrium Overconsumption," American Economic Review, American Economic Association, vol. 93(1), pages 423-428, March.
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