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Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption

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  • Campbell Leith

    (University of Glasgow)

  • Ioana Moldovan

    (University of Glasgow)

  • Raffaele Rossi

    (University of Milano-Bicocca)

Abstract

In this paper we consider the implications of habits for optimal monetary policy, when those habits either exist at the level of the aggregate basket of consumption goods (`superficial' habits) or at the level of individual goods (`deep' habits: see Ravn, Schmitt-Grohe, and Uribe (2006)). External habits generate an additional distortion in the economy and create new trade-offs for optimal policy, as the policy maker does not respond as aggressively to technology shocks in order to avoid exacerbating the habits externality. This can dramatically affect both the parameterization of optimal simple rules, as well as their determinacy properties. These effects are particularly strong when habits are of the deep kind. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 15 (2012)
Issue (Month): 3 (July)
Pages: 416-435

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Handle: RePEc:red:issued:09-154

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Keywords: Consumption habits; Nominal inertia; Optimal monetary policy;

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References

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  1. Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2012. "Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 416-435, July.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," NBER Working Papers 8403, National Bureau of Economic Research, Inc.
  3. BOUAKEZ, Hafedh & CARDIA, Emanuela & RUGE-MURCIA, Francisco J., 2002. "Habit Formation and the Persistence of Monetary Shocks," Cahiers de recherche 2002-08, Universite de Montreal, Departement de sciences economiques.
  4. Ravn, Morten O. & Schmitt-Grohe, Stephanie & Uribe, Martín & Uuskula, Lenno, 2010. "Deep habits and the dynamic effects of monetary policy shocks," Journal of the Japanese and International Economies, Elsevier, vol. 24(2), pages 236-258, June.
  5. Smets, Frank & Wouters, Raf, 2007. "Shocks and frictions in US business cycles: a Bayesian DSGE approach," Working Paper Series 0722, European Central Bank.
  6. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  7. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  8. Leith, Campbell & Malley, Jim, 2005. "Estimated general equilibrium models for the evaluation of monetary policy in the US and Europe," European Economic Review, Elsevier, vol. 49(8), pages 2137-2159, November.
  9. Levine, Paul & Pearlman, Joseph & Pierse, Richard, 2008. "Linear-quadratic approximation, external habit and targeting rules," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3315-3349, October.
  10. Kozicki, Sharon & Tinsley, P. A., 2002. "Dynamic specifications in optimizing trend-deviation macro models," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1585-1611, August.
  11. Jeffery D. Amato & Thomas Laubach, 2001. "Implications of habit formation for optimal monetary policy," Finance and Economics Discussion Series 2001-58, Board of Governors of the Federal Reserve System (U.S.).
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  14. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers 4334, C.E.P.R. Discussion Papers.
  15. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2006. "Should Central Banks Target Consumer Prices or the Exchange Rate?," Economic Journal, Royal Economic Society, vol. 116(512), pages F208-F231, 06.
  16. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  17. 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.
  18. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  19. 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.
  20. Currie,David & Levine,Paul, 1993. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521441964, April.
  21. Zubairy, Sarah, 2010. "Deep Habits, Nominal Rigidities and Interest Rate Rules," MPRA Paper 26053, University Library of Munich, Germany.
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  23. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
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Citations

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Cited by:
  1. Giovanni MELINA & Stefania VILLA, 2012. "Fiscal policy and lending relationships," Center for Economic Studies - Discussion papers ces12.06, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  2. David M. Arseneau & Ryan Chahrour & Sanjay K. Chugh & Alan Finkelstein Shapiro, 2013. "Optimal Fiscal and Monetary Policy in Customer Markets," Boston College Working Papers in Economics 842, Boston College Department of Economics.
  3. Xiaoshan Chen & Tatiana Kirsanova & Campbell Leith, 2013. "How Optimal is US Monetary Policy?," Working Papers 2013_08, Business School - Economics, University of Glasgow.
  4. Marcin Kolasa & Giovanni Lombardo, 2011. "Financial frictions and optimal monetary policy in an open economy," National Bank of Poland Working Papers 91, National Bank of Poland, Economic Institute.
  5. Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2008. "Optimal monetary policy in a new Keynesian model with habits in consumption," Working Papers 2008_30, Business School - Economics, University of Glasgow, revised Dec 2008.
  6. 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.
  7. William Barnett & Unal Eryilmaz, 2012. "An Analytical and Numerical Search for Bifurcations in Open Economy New Keynesian Models," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 201210, University of Kansas, Department of Economics, revised Aug 2012.
  8. Zubairy, Sarah, 2010. "Deep Habits, Nominal Rigidities and Interest Rate Rules," MPRA Paper 26053, University Library of Munich, Germany.
  9. Punnoose Jacob, 2013. "Deep habits, price rigidities and the consumption response to Government spending," Reserve Bank of New Zealand Discussion Paper Series DP2013/03, Reserve Bank of New Zealand.
  10. Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2012. "Online Appendix to "Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption"," Technical Appendices 09-154, Review of Economic Dynamics.
  11. Ivan Petrella & Raffaele Rossi & Emiliano Santoro, 2012. "Monetary Policy with Sectoral Linkages and Durable Goods," Discussion Papers 12-19, University of Copenhagen. Department of Economics.

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