Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption

55 Pages Posted: 13 Aug 2009

See all articles by Campbell Leith

Campbell Leith

University of Glasgow - Department of Economics

Ioana Moldovan

University of Glasgow

Raffaele Rossi

Lancaster University

Date Written: July 20, 2009


While consumption habits have been utilised as a means of generating a hump shaped output response to monetary policy shocks in sticky-price New Keynesian economies, there is relatively little analysis of the impact of habits (particularly, external habits) on optimal policy. In this paper we consider the implications of external habits for optimal monetary policy, when those habits either exist at the level of the aggregate basket of consumption goods (‘superficial’ habits) or at the level of individual goods (‘deep’ habits: see Ravn, Schmitt-Grohe, and Uribe (2006)). External habits generate an additional distortion in the economy, which implies that the flex-price equilibrium will no longer be efficient and that policy faces interesting new trade-offs and potential stabilisation biases. Furthermore, the endogenous mark-up behaviour, which emerges when habits are deep, can also significantly affect the optimal policy response to shocks, as well as dramatically affecting the stabilising properties of standard simple rules.

Keywords: consumption habits, nominal inertia, optimal monetary policy

JEL Classification: E3, E57, E61

Suggested Citation

Leith, Campbell and Moldovan, Ioana and Rossi, Raffaele, Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption (July 20, 2009). ECB Working Paper No. 1076, Available at SSRN: https://ssrn.com/abstract=1433731 or http://dx.doi.org/10.2139/ssrn.1433731

Campbell Leith (Contact Author)

University of Glasgow - Department of Economics ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom
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++44 141 330 4940 (Fax)

Ioana Moldovan

University of Glasgow ( email )

Adam Smith Business School
Glasgow, Scotland G12 8LE
United Kingdom

Raffaele Rossi

Lancaster University ( email )

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