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Optimal monetary policy in a new Keynesian model with habits in consumption

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  • Leith, Campbell
  • Moldovan, Ioana
  • Rossi, Raffaele

Abstract

While consumption habits have been utilised as a means of generating a hump shaped output response to monetary policy shocks in sticky-price New Keynesian economies, there is relatively little analysis of the impact of habits (particularly, external habits) on optimal policy. In this paper we consider the implications of external 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, which implies that the flex-price equilibrium will no longer be efficient and that policy faces interesting new trade-offs and potential stabilisation biases. Furthermore, the endogenous mark-up behaviour, which emerges when habits are deep, can also significantly affect the optimal policy response to shocks, as well as dramatically affecting the stabilising properties of standard simple rules. JEL Classification: E30, E57, E61

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1076.

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Date of creation: Jul 2009
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Handle: RePEc:ecb:ecbwps:20091076

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Keywords: consumption habits; nominal inertia; optimal monetary policy;

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References

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  1. Smets, Frank & Wouters, Rafael, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," CEPR Discussion Papers 6112, C.E.P.R. Discussion Papers.
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  6. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(6), pages 1702-1725, September.
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Citations

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Cited by:
  1. 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.
  2. Punnoose Jacob, 2013. "Deep Habits, Price Rigidities and the Consumption Response to Government Spending," CAMA Working Papers 2013-72, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. 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.
  4. Chen, Xiaoshan & Kirsanova, Tatiana & Leith, Campbell, 2013. "How Optimal is US Monetary Policy?," Stirling Economics Discussion Papers, University of Stirling, Division of Economics 2013-05, University of Stirling, Division of Economics.
  5. Giovanni MELINA & Stefania VILLA, 2012. "Fiscal policy and lending relationships," Center for Economic Studies - Discussion papers, Katholieke Universiteit Leuven, Centrum voor Economische Studiën ces12.06, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  6. Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2008. "Optimal monetary policy in a new Keynesian model with habits in consumption," Working Papers, Business School - Economics, University of Glasgow 2008_30, Business School - Economics, University of Glasgow, revised Dec 2008.
  7. Pietro Cova & Patrizio Pagano & Massimiliano Pisani, 2014. "Foreign exchange reserve diversification and the "exorbitant privilege"," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 964, Bank of Italy, Economic Research and International Relations Area.
  8. Sanjay K. Chugh & David M. Arseneau, 2008. "Optimal Fiscal and Monetary Policy in Customer Markets," 2008 Meeting Papers 101, Society for Economic Dynamics.
  9. 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.
  10. 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.
  11. 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.
  12. Zubairy, Sarah, 2010. "Deep Habits, Nominal Rigidities and Interest Rate Rules," MPRA Paper 26053, University Library of Munich, Germany.

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