Optimal monetary policy in a New Keynesian model with habits in consumption

Leith, Campbell; Moldovan, Ioana; Rossi, Raffaele

doi:10.1016/j.red.2012.03.001

Cited by 50 publications

(48 citation statements)

References 27 publications

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“…2 Furthermore, we assume the economy is subject to both price and inflation inertia. Both effects have been found to be important in capturing the hump-shaped responses of output and inflation to shocks evident in VAR-based studies, and are often employed in empirical 2 For a comparison of the implications for optimal policy of alternative forms of habits see Leith et al (2012). applications of the New Keynesian model. 3…”

Section: The Modelmentioning

confidence: 99%

“…In the absence of inflation inertia and habits, the model would reduce to the benchmark New Keynesian model considered by Woodford (2003) where only cost-push shocks generate a meaningful trade-off for the monetary policy maker, as monetary policy can optimally respond to technology and taste shocks without generating any inflation. Adding inflation indexation to pricing contracts creates further policy trade-offs (see Steinsson, 2003), as does the externality associated with habits formation (see Leith et al, 2012), both of which would imply that the inflation consequences of taste and technology shocks are no-longer perfectly offset by monetary policy. Accordingly, in order to replicate the observed fluctuations in inflation, optimal policy must be faced with meaningful trade-offs which prevent it from perfectly stabilizing inflation, and the estimated degree of habits, price indexation and cost-push shocks provide the most data coherent means of doing so.…”

Section: Simple Rules and Optimal Policymentioning

confidence: 99%

“…Amato and Laubach (2004) and Leith et al (2012) both consider the optimal policy response to habits, where the former paper assumes habits to be internal (i.e. households anticipate the impact of current consumption on their future utility via habits effects) and the latter external (households fail to internalize the impact of their consumption decisions on the future utility of themselves and others).…”

Section: The Role Of Inertiamentioning

confidence: 99%

“…In the presence of habits externalities this is no longer the case (see Leith et al, 2012). Accordingly, the differing responses to various shocks across the different descriptions of optimal policy in the presence of the additional frictions caused by habits and inflation inertia, were exploited by the estimation procedure in explaining the data.…”

Section: The Role Of Inertiamentioning

confidence: 99%

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How optimal is US monetary policy?

Chen

Kirsanova

Leith

2017

Journal of Monetary Economics

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Most of the literature estimating DSGE models for monetary policy analysis assume that policy follows a simple rule. In this paper we allow policy to be described by various forms of optimal policy -commitment, discretion and quasi-commitment. We find that, even after allowing for Markov switching in shock variances, the inflation target and/or rule parameters, the data preferred description of policy is that the US Fed operates under discretion with a marked increase in conservatism after the 1970s. Parameter estimates are similar to those obtained under simple rules, except that the degree of habits is significantly lower and the prevalence of cost-push shocks greater. Moreover, we find that the greatest welfare gains from the 'Great Moderation' arose from the reduction in the variances in shocks hitting the economy, rather than increased inflation aversion. However, much of the high inflation of the 1970s could have been avoided had policy makers been able to commit, even without adopting stronger anti-inflation objectives. More recently the Fed appears to have temporarily relaxed policy following the 1987 stock market crash, and has lost, without regaining, its post-Volcker conservatism following the bursting of the dot-com bubble in 2000.

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Section: The Modelmentioning

confidence: 99%

Section: Simple Rules and Optimal Policymentioning

confidence: 99%

Section: The Role Of Inertiamentioning

confidence: 99%

Section: The Role Of Inertiamentioning

confidence: 99%

See 2 more Smart Citations

How optimal is US monetary policy?

Chen

Kirsanova

Leith

2017

Journal of Monetary Economics

Self Cite

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“…They examine optimal commitment and optimised simple rules as do Leith et al (2012) who extend the model to incorporate deep habits. Another seminal contribution by Benigno and Woodford (2004) studied optimal adjustment in fiscal variables consistent with leaving debt as well as taxes at a high level in the long run when the shock(s) to the economy has adverse public finance implications.…”

Section: Introductionmentioning

confidence: 99%

Optimal Fiscal and Monetary Policy, Debt Crisis and Management

et al. 2017

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The initial government debt-to-GDP ratio and the government's commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with "normal shocks", perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds -under commitment -the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.

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A fiscal stimulus with deep habits and optimal monetary policy

et al. 2012

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A New-Keynesian model with deep habits and optimal monetary policy delivers a fiscal multiplier above one and the crowding-in effect on private consumption obtainable in a Real Business Cycle model à la Ravn et al. (2006). Optimized Taylor-type or price-level interest rate rules yield results close to optimal policy and dominate a conventional Taylor interest rate rule. Private consumption is crowded out only if the Taylor rule is sub-optimal and then negates the fiscal stimulus by responding strongly to the output gap, or if the ability to commit is absent. At the zero lower bound private consumption is always crowded in across simple rules.JEL classification: E30, E62.

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Optimal monetary policy in a New Keynesian model with habits in consumption

Abstract: 4Non-technical summary 5

Cited by 50 publications

References 27 publications

How optimal is US monetary policy?

How optimal is US monetary policy?

Optimal Fiscal and Monetary Policy, Debt Crisis and Management

A fiscal stimulus with deep habits and optimal monetary policy

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