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Optimal Monetary Policy with Durable and Non-Durable Goods

  • Christopher J. Erceg
  • Andrew T. Levin

The durable goods sector is much more interest sensitive than the non-durables sector, and these sectoral differences have important implications for monetary policy. In this paper, we perform VAR analysis of quarterly US data and find that a monetary policy innovation has a peak impact on durable expenditures that is roughly five times as large as its impact on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impulse response functions of the data. While the social welfare function involves sector-specific output gaps and inflation rates, we find that performance of the optimal policy rule can be closely approximated by a very simple rule that targets a weighted average of aggregate wage and price inflation rates. In contrast, some commonly-prescribed policy rules (such as strict5 price inflation targeting and Taylor's rule) perform very poorly in terms of social welfare. JEL Classification: E31, E32, E52

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2002 with number 343.

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Date of creation: 01 Jul 2002
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Handle: RePEc:sce:scecf2:343
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  1. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," CFS Working Paper Series 2003/13, Center for Financial Studies (CFS).
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  15. repec:nbr:nberre:0126 is not listed on IDEAS
  16. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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  19. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
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