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Deep Habits and the Dynamic Effects of Monetary Policy Shocks

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  • Ravn, Morten
  • Uribe, Martín
  • Schmitt-Grohé, Stephanie
  • Uusküla, Lenno

Abstract

This paper introduces deep habits into a sticky-price sticky-wage economy and asks whether the countercyclical markup movements induced by deep habits is helpful for accounting for the dynamic effects of monetary policy shocks. We find that this is the case: When allowing for deep habits, the model can account very precisely for the persistent impact of monetary policy shocks on aggregate consumption and for the impact on inflation that other models have hard a time explaining. In particular, the model can account both for the price puzzle and for inflation persistence. We also show that the deep habits mechanism and nominal rigidities are complementary: The deep habits model can account for the dynamic effects of monetary policy shock at low to moderate levels of nominal rigidities. We show that the results are stable over time and are not caused by monetary policy changes.

Suggested Citation

  • Ravn, Morten & Uribe, Martín & Schmitt-Grohé, Stephanie & Uusküla, Lenno, 2009. "Deep Habits and the Dynamic Effects of Monetary Policy Shocks," CEPR Discussion Papers 7128, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:7128
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    Keywords

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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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