Optimal monetary policy with durable goods and non-durable goods

Christopher John Erceg and Andrew Theo Levin ()

No 179, Working Paper Series from European Central Bank

Abstract: 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 impacts 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 strict price inflation targeting and Taylor's rule) perform very poorly in terms of social welfare. JEL Classification: E31; E32; E52.

Keywords: VAR analysis; DGE models; sectoral disaggregation. (search for similar items in EconPapers)
Date: 2002-09
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