Implications of habit formation for optimal monetary policy

Jeffery Amato and Thomas Laubach
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Jeffery Amato: Goldman Sachs International

No 121, BIS Working Papers from Bank for International Settlements

Abstract: 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 maximisation includes output stablisation, as well as inflation and output gap stablisation. 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.

Keywords: interest rate rules; habit formation; optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2002-11
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Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Implications of habit formation for optimal monetary policy (2004)
Working Paper: Implications of habit formation for optimal monetary policy (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:121

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