Deep habits in the New Keynesian Phillips curve

Thomas Lubik and Wing Leong Teo

No 11-08, Working Paper from Federal Reserve Bank of Richmond

Abstract: We derive and estimate a New Keynesian Phillips curve (NKPC) in a model where consumers are assumed to have deep habits. Habits are deep in the sense that they apply to individual consumption goods instead of aggregate consumption. This alters the NKPC in a fundamental manner as it introduces expected and contemporaneous consumption growth as well as the expected marginal value of future demand as additional driving forces for inflation dynamics. We construct the driving process in the deep habits NKPC by using the model's optimality conditions to impute time series for unobservable variables. The resulting series is considerably more volatile than unit labor cost. General Methods of Moments (GMM) estimation of the NKPC shows an improved fit and a much lower degree of indexation than in the standard NKPC. Our analysis also reveals that the crucial parameters for the performance of the deep habit NKPC are the habit parameter and the substitution elasticity between differentiated products. The results are broadly robust to alternative specifications.

Keywords: Inflation (Finance); Monetary policy (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Deep Habits in the New Keynesian Phillips Curve (2014)
Working Paper: Deep Habits in the New Keynesian Phillips Curve (2012)
Working Paper: Deep Habits in the New Keynesian Phillips Curve (2011)
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