Time-varying volatility, precautionary saving and monetary policy

Michael Hatcher

No 440, Bank of England working papers from Bank of England

Abstract: This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.

Keywords: Time-varying volatility; precautionary saving; monetary policy; DSGE models. (search for similar items in EconPapers)
JEL-codes: E21 E32 E58 G12 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2011-10-31
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0440

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