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Monetary and Fiscal Policy under Deep Habits

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  • Campbell Leith

    ()

  • Ioana Moldovan

    ()

  • Raffaele Rossi

    ()

Abstract

Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially non¬linear) policy rules to mimic fully optimal policy.

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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Conference Paper Series with number 0905.

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Date of creation: Sep 2009
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Handle: RePEc:san:cdmacp:0905

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Keywords: Monetary Policy; Fiscal Policy; Deep Habits; New Keynesian.;

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References

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  1. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2963, C.E.P.R. Discussion Papers.
  2. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, American Economic Association, vol. 90(3), pages 356-366, June.
  3. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  4. Morten O. Ravn & Stephanie Schmitt-Grohe & Martín Uribe & Lenno Uuskula, 2008. "Deep Habits and the Dynamic Effects of Monetary Policy Shocks," Economics Working Papers, European University Institute ECO2008/40, European University Institute.
  5. Jordi Galí & J. David López-Salido & Javier Vallés, 2002. "Understanding the effects of government spending on consumption," Economics Working Papers 911, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2005.
  6. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2009. "Monetary and Fiscal Policy Interaction: The Current Consensus Assignment in the Light of Recent Developments," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 119(541), pages F482-F496, November.
  7. Leith, Campbell & von Thadden, Leopold, 2006. "Monetary and fiscal policy interactions in a New Keynesian model with capital accumulation and non-Ricardian consumers," Working Paper Series, European Central Bank 0649, European Central Bank.
  8. Lombardo, Giovanni & Vestin, David, 2008. "Welfare implications of Calvo vs. Rotemberg-pricing assumptions," Economics Letters, Elsevier, Elsevier, vol. 100(2), pages 275-279, August.
  9. Peter N. Ireland, 2004. "Technology Shocks in the New Keynesian Model," NBER Working Papers 10309, National Bureau of Economic Research, Inc.
  10. Simon Wren-Lewis & Fabian Eser, 2009. "When is Monetary Policy All we Need?," Economics Series Working Papers 430, University of Oxford, Department of Economics.
  11. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  12. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, MIT Press, vol. 1(5), pages 1123-1175, 09.
  13. 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.
  14. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 110(462), pages C93-108, March.
  15. Schmitt-Grohé, Stephanie & Uribe, Martín, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4334, C.E.P.R. Discussion Papers.
  16. Jinill Kim and Sunghyun Henry Kim, 2001. "Spurious Welfare Reversals in International Business Cycle Models," Computing in Economics and Finance 2001, Society for Computational Economics 3, Society for Computational Economics.
  17. Linnemann, Ludger, 2006. "Interest rate policy, debt, and indeterminacy with distortionary taxation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 30(3), pages 487-510, March.
  18. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 27(1), pages 129-147, February.
  19. Hafedh Bouakez & Emanuela Cardia & Francisco J. Ruge-Murcia, 2002. "Habit Formation and the Persistence of Monetary Shocks," Working Papers, Bank of Canada 02-27, Bank of Canada.
  20. Levine, Paul & Pearlman, Joseph & Pierse, Richard, 2008. "Linear-quadratic approximation, external habit and targeting rules," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(10), pages 3315-3349, October.
  21. Tatiana Kirsanova & Campbell Leith & Simon Wren-Lewis, 2006. "Should Central Banks Target Consumer Prices or the Exchange Rate?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 116(512), pages F208-F231, 06.
  22. Valerie A. Ramey, 2011. "Identifying Government Spending Shocks: It's all in the Timing," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 1-50.
  23. Florio, Anna, 2006. "Asymmetric interest rate smoothing: The Fed approach," Economics Letters, Elsevier, Elsevier, vol. 93(2), pages 190-195, November.
  24. Naveen Srinivasan & Vidya Mahambare & M. Ramachandran, 2006. "UK monetary policy under inflation forecast targeting: is behaviour consistent with symmetric preferences?," Oxford Economic Papers, Oxford University Press, vol. 58(4), pages 706-721, October.
  25. Leith, Campbell & Wren-Lewis, Simon, 2009. "When is Monetary Policy All we Need?," SIRE Discussion Papers, Scottish Institute for Research in Economics (SIRE) 2009-25, Scottish Institute for Research in Economics (SIRE).
  26. Dolado, Juan J. & Maria-Dolores, Ramon & Naveira, Manuel, 2005. "Are monetary-policy reaction functions asymmetric?: The role of nonlinearity in the Phillips curve," European Economic Review, Elsevier, Elsevier, vol. 49(2), pages 485-503, February.
  27. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
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Cited by:
  1. Cristiano Cantore & Paul Levine & Giovanni Melina, 2011. "A Fiscal Stimulus and Jobless Recovery," School of Economics Discussion Papers, School of Economics, University of Surrey 1111, School of Economics, University of Surrey.
  2. Adam, Klaus, 2010. "Government Debt and Optimal Monetary and Fiscal Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8064, C.E.P.R. Discussion Papers.

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