Loss Aversion and the Asymmetric Transmission of Monetary Policy

Edoardo Gaffeo, Ivan Petrella, Damjan Pfajfar and Emiliano Santoro

No 12-21, Discussion Papers from University of Copenhagen. Department of Economics

Abstract: There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households' utility depends on consumption deviations from a reference level below which loss aversion is displayed. In line with the prospect theory pioneered by Kahneman and Tversky (1979), losses in consumption loom larger than gains. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and infl?ation. The resulting state-dependent trade-off between output and infl?ation stabilization recommends stronger policy activism towards in?flation during expansions

Keywords: Asymmetry; Monetary Policy; Business Cycle; Prospect Theory (search for similar items in EconPapers)
JEL-codes: D03 D11 E32 E42 E52 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2012-07-16
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Related works:
Journal Article: Loss aversion and the asymmetric transmission of monetary policy (2014)
Working Paper: Loss Aversion and the Asymmetric Transmission of Monetary Policy (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:kud:kuiedp:1221

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