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

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  • Campbell Leith
  • Ioana Moldovan
  • Raffaele Rossi

Abstract

While consumption habits have been utilised as a means of generating a humpshaped 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.

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Bibliographic Info

Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2008_30.

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Date of creation: Nov 2008
Date of revision: Dec 2008
Handle: RePEc:gla:glaewp:2008_30

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

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References

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  1. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
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  7. Zubairy, Sarah, 2010. "Deep Habits, Nominal Rigidities and Interest Rate Rules," MPRA Paper 26053, University Library of Munich, Germany.
  8. 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.
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