Policy Design in a Model with Swings in Risk Appetite
AbstractThis paper studies the policy implications of habits and cyclical changes in agents' appetite for risk-taking. To do so, it analyses the non-linear solution of a New Keynesian (NK) model, in which slow-moving habits help match the cyclical properties of risk-premia. Our findings suggest that the presence of habits and swings in risk appetite can materially affect policy prescriptions. As in Ljungqvist and Uhlig (2000), a counter-cyclical fiscal instrument can eliminate habit-related externalities. Alternatively, monetary policy can partially curb the associated overconsumption by responding to risk premia. Specifically, periods in which risk premia are elevated (compressed) merit a looser (tighter) policy stance. However, the associated welfare gains appear quantitatively small.
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Bibliographic InfoPaper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1170.
Date of creation: Oct 2012
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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP
Policy design; cyclical risk aversion; New Keynesian model; habit formation;
Other versions of this item:
- Bianca De Paoli & Pawel Zabczyk, 2013. "Policy design in a model with swings in risk appetite," Oxford Economic Papers, Oxford University Press, vol. 65(suppl_1), pages i146-i169, April.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-03 (All new papers)
- NEP-MAC-2012-11-03 (Macroeconomics)
- NEP-UPT-2012-11-03 (Utility Models & Prospect Theory)
You can help add them by filling out this form.
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