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Monetary and Fiscal Policy under Deep Habits

Author

Listed:
  • 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.

Suggested Citation

  • Campbell Leith & Ioana Moldovan & Raffaele Rossi, 2009. "Monetary and Fiscal Policy under Deep Habits," CDMA Conference Paper Series 0905, Centre for Dynamic Macroeconomic Analysis.
    • Handle: RePEc:san:cdmacp:0905
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    File URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0905.pdf
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    Cited by:

    1. Adam, Klaus, 2011. "Government debt and optimal monetary and fiscal policy," European Economic Review, Elsevier, vol. 55(1), pages 57-74, January.
    2. Aloui, Rym, 2024. "Habit formation and the government spending multiplier," Economic Modelling, Elsevier, vol. 132(C).
    3. Cristiano Cantore & Paul Levine & Giovanni Melina, 2014. "Deep versus superficial habit: It’s all in the persistence," School of Economics Discussion Papers 0714, School of Economics, University of Surrey.
    4. Giorgio Motta & Patrizio Tirelli, 2012. "Optimal Simple Monetary and Fiscal Rules under Limited Asset Market Participation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1351-1374, October.
    5. Cristiano Cantore & Paul Levine & Giovanni Melina, 2014. "A Fiscal Stimulus and Jobless Recovery," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(3), pages 669-701, July.
    6. Hillary Chijindu Ezeaku & Imo Godwin Ibe & Uche Boniface Ugwuanyi & N. J. Modebe & Emmanuel Kalu Agbaeze, 2018. "Monetary Policy Transmission and Industrial Sector Growth: Empirical Evidence From Nigeria," SAGE Open, , vol. 8(2), pages 21582440187, April.
    7. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Bank of Finland Research Discussion Papers 5/2020, Bank of Finland.
    8. Thomas A. Lubik & Wing Leong Teo, 2014. "Deep Habits in the New Keynesian Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(1), pages 79-114, February.
    9. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Research Discussion Papers 5/2020, Bank of Finland.
    10. Taisuke Nakata, 2017. "Optimal Government Spending at the Zero Lower Bound: A Non-Ricardian Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 150-169, January.
    11. Lawrence B. Dacuycuy, 2016. "Preferences, government investment, and disbursement sudden stops," Philippine Review of Economics, University of the Philippines School of Economics and Philippine Economic Society, vol. 53(1), pages 1-18, June.
    12. Cheng-wei Chang & Ting-wei Lai, 2024. "Government spending and monopolistic competition with heterogeneous firm productivity," Journal of Economics, Springer, vol. 141(2), pages 101-135, March.
    13. Okano, Mitsuhiro, 2025. "Optimal monetary policy in a two-country New Keynesian model with deep consumption habits," Macroeconomic Dynamics, Cambridge University Press, vol. 29, pages 1-1, January.
    14. Ambrocio, Gene, 2023. "Demographic aging and the New Keynesian Phillips Curve," Bank of Finland Research Discussion Papers 16/2023, Bank of Finland.
    15. Vines, David & Luk, Paul, 2015. "The Optimal Coordination of Fiscal and Monetary Policy in a New Keynesian Framework," CEPR Discussion Papers 10895, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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