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Optimal monetary policy with durable goods and non-durable goods

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Author Info
Christopher J. Erceg () (Federal Reserve Board - Trade and Quantitative Studies, 20th St. and Constitution Ave., Washington, DC 20551, United States.)
Andrew T. Levin () (Board of Governors of the Federal Reserve System, 20th and C Streets, NW, Washington, DC 20551, United States.)

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Abstract

The durable goods sector is much more interest sensitive than the non-durables sector, and these sectoral differences have important implications for monetary policy. In this paper, we perform VAR analysis of quarterly US data and find that a monetary policy innovation has a peak impact on durable expenditures that is roughly five times as large as its impacts on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impulse response functions of the data. While the social welfare function involves sector-specific output gaps and inflation rates, we find that performance of the optimal policy rule can be closely approximated by a very simple rule that targets a weighted average of aggregate wage and price inflation rates. In contrast, some commonly-prescribed policy rules (such as strict price inflation targeting and Taylor's rule) perform very poorly in terms of social welfare. JEL Classification: E31; E32; E52.

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Paper provided by European Central Bank in its series Working Paper Series with number 179.

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Length: 39 pages
Date of creation: Sep 2002
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Handle: RePEc:ecb:ecbwps:20020179

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Related research
Keywords: VAR analysis; DGE models; sectoral disaggregation.;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Henderson, Dale W. & McKibbin, Warwick J., 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 221-317, December. [Downloadable!] (restricted)
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  2. Hornstein, Andreas & Praschnik, Jack, 1997. "Intermediate inputs and sectoral comovement in the business cycle," Journal of Monetary Economics, Elsevier, vol. 40(3), pages 573-595, December. [Downloadable!] (restricted)
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  3. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January. [Downloadable!] (restricted)
  4. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Gali, Jordi, 1993. "Variability of Durable and Nondurable Consumption: Evidence for Six O.E.C.D. Countries," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 418-28, August. [Downloadable!] (restricted)
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  6. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August. [Downloadable!] (restricted)
  7. Marvin Goodfriend, 1997. "Monetary policy comes of age: a 20th century odyssey," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-22. [Downloadable!]
  8. Baxter, Marianne, 1996. "Are Consumer Durables Important for Business Cycles?," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 147-55, February. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. [Downloadable!] (restricted)
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  11. 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. [Downloadable!] (restricted)
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  12. Athanasios Orphanides & Volker Wieland, 1998. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Finance and Economics Discussion Series 1998-35, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  13. Michael J. Hamburger, 1967. "Interest rates and the demand for consumer durable goods," Staff Studies 41, Board of Governors of the Federal Reserve System (U.S.).
  14. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October. [Downloadable!] (restricted)
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  15. Parks, Richard W, 1974. "The Demand and Supply of Durable Goods and Durability," American Economic Review, American Economic Association, vol. 64(1), pages 37-55, March. [Downloadable!] (restricted)
  16. 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. [Downloadable!] (restricted)
  17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
  18. Mishkin, Frederic S, 1976. "Illiquidity, Consumer Durable Expenditure, and Monetary Policy," American Economic Review, American Economic Association, vol. 66(4), pages 642-54, September. [Downloadable!] (restricted)
  19. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc. [Downloadable!]
  20. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Huw Dixon & Engin Kara, 2005. "Persistence and nominal inertia in a generalized Taylor economy - how longer contracts dominate shorter contracts," Working Paper Series 489, European Central Bank. [Downloadable!]
    Other versions:
  2. Ippei Fujiwara, Naoko Hara, Naohisa Hirakata, Takeshi Kimura, and Shinichiro Watanabe, 2007. "Japanese Monetary Policy during the Collapse of the Bubble Economy: A View of Policymaking under Uncertainty," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 25(2), pages 89-128, November. [Downloadable!]
    Other versions:
  3. BOUAKEZ, Hafed & CARDIA Emanuela & RUGE-MURCIA, Francisco, 2005. "The Transmission of Monetary Policy in a Multi-Sector Economy," Cahiers de recherche 2005-16, Universite de Montreal, Departement de sciences economiques. [Downloadable!]
  4. Javier Andrés & Pablo Burriel & Ángel Estrada, 2006. "BEMOD: a DSGE model for the Spanish economy and the rest of the Euro area," Banco de España Working Papers 0631, Banco de España. [Downloadable!]
  5. Marek Jarocinski & Frank Smets, 2008. "House prices and the stance of monetary policy," Working Paper Series 891, European Central Bank. [Downloadable!]
    Other versions:
  6. Alexander L. Wolman & Fan Ding, 2005. "Inflation and changing expenditure shares," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-20. [Downloadable!]
  7. Héctor Bravo L. & Carlos García T. & Verónica Mies M. & Matías Tapia G., 2003. "Heterogeneidad de la Transmisión Monetaria: Efectos Sectoriales y Regionales," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 6(3), pages 5-26, December. [Downloadable!]
  8. Campbell Leith & Jim Malley, 2003. "A Sectoral Analysis of Price-Setting Behavior in US Manufacturing Industries," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  9. repec:bep:mactop:v:4:y:2004:i:1:p:1178-1178 is not listed on IDEAS
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