Implications of habit formation for optimal monetary policy

By J. Amato, Thomas Laubach. 2001

163 citations recorded by the source corpus.

We study the implications for optimal monetary policy of introducing habit formation in consumption into a general equilibrium model with sticky prices. Habit formation affects the model's endogenous dynamics through its effects on both aggregate demand and households' supply of output. We show that the objective of monetary policy consistent with welfare maximization includes output stabilization, as well as inflation and output gap stabilization. We find that the variance of output increases under optimal policy, even though it acquires a higher implicit weight in the welfare function. We also find that a simple interest rate rule nearly achieves the welfare-optimal allocation, regardless of the degree of habit formation. In this rule, the optimal responses to inflation and the lagged interest rate are both declining in the size of the habit, although super-inertial policies remain optimal.

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/f1c08940d7313b6c34e28137f531974f993188b4

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In Economics and Econometrics

Citations in the corpus

Estimated General Equilibrium Models for the Evaluation of Monetary Policy in the Us and Europe (2005, background): “The values of θp, and φ are taken from Galí et al 2001 who also estimate a price hybrid NKPC conditioned on these values.”
Inflation Dynamics, Marginal Cost, and the Output Gap: Evidence from Three Countries (2005, methodology): “In particular, as shown in Roberts (1995), the forward-looking We thank Jordi Galı́, Mark Gertler, Robert Gordon, Peter Ireland, Thomas Laubach, Argia Sbordone, Frank Smets, Michael Woodford, and participants at ECB, Bank of England, University of York, and University of Western Ontario seminars and”
Money in an Estimated Business Cycle Model of the Euro Area (2006, unknown): “To close the model we include the AR(1) distribution for the aggregate demand shock (2.”
The Yield Curve and Macroeconomic Dynamics (2008, unknown): “it = 1 I + ( t t ) + (yt y t ) + Iit 1 + t (1) t = t 1 + " t (2)”
Monetary Policy and Inflation Dynamics (2004, unknown): “Amato and Laubach (2004) show how habit persistence can lead to a specification with lagged as well as future output.”
Optimal Inflation Targeting Rules (2003, unknown): “15) implies that aggregate demand is determined as a purely forward-looking function of the expected path of real interest rates and exogenous disturbances. Many empirical models of the monetary transmission mechanism instead imply that the current level of aggregate real expenditure should depend p”
Has Monetary Policy Become More Effective? (2006, background): “In addition, we assume that the government purchases an aggregate Gt of all goods in the economy of the form (3).”
Money and the natural rate of interest: structural estimates for the United States and the Euro area (2007, unknown): “This is con(cid:133)rmed when we generate the natural-rate realization implied by the alternative parameterization of Amato and Laubach (2004), who assume white noise real shocks.”