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Monetary and Fiscal Policy under Deep Habits

  • Campbell Leith


  • Ioana Moldovan


  • Raffaele Rossi


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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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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