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Persistent Habits, optimal Monetary Policy Inertia and Interest Rate Smoothing

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  • Corrado, L.
  • Holly, S.
  • Raissi, M.

Abstract

Dynamic stochastic general equilibrium models featuring imperfect competition and nominal rigidities have become central for the analysis of the monetary transmission mechanism and for understanding the conduct of monetary policy. However, it is agreed that the benchmark model fails to generate the persistence of output and inflation that is observed in the data. Moreover, it cannot provide a theoretically well-grounded justification for the interest rate smoothing behaviour of monetary authorities. This paper attempts to overcome these deficiencies by embedding a multiplicative habit specification in a New Keynesian model. We show that this particular form of habit formation can explain why monetary authorities smooth interest rates.

Suggested Citation

  • Corrado, L. & Holly, S. & Raissi, M., 2012. "Persistent Habits, optimal Monetary Policy Inertia and Interest Rate Smoothing," Cambridge Working Papers in Economics 1247, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:1247
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    References listed on IDEAS

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    More about this item

    Keywords

    Multiplicative habits; interest rate inertia; optimal monetary policy.;
    All these keywords.

    JEL classification:

    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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