Loss Aversion and the Asymmetric Transmission of Monetary Policy

55 Pages Posted: 25 Sep 2014

See all articles by Edoardo Gaffeo

Edoardo Gaffeo

University of Trento - Department of Economics and Management

Ivan Petrella

University of Warwick; Centre for Economic Policy Research (CEPR)

Damjan Pfajfar

Board of Governors of the Federal Reserve System

Emiliano Santoro

Catholic University of the Sacred Heart of Milan - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: August 2014

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 householdsÂ’ utility depends on consumption deviations from a reference level below which loss aversion is displayed. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and inflation. Contractions face the Central Bank with higher responsiveness of output to interest rate changes, as well as a flatter aggregate supply schedule.

Keywords: asymmetry, business cycle, monetary policy, prospect theory

JEL Classification: D03, D11, E32, E42, E52

Suggested Citation

Gaffeo, Edoardo and Petrella, Ivan and Pfajfar, Damjan and Santoro, Emiliano, Loss Aversion and the Asymmetric Transmission of Monetary Policy (August 2014). CEPR Discussion Paper No. DP10105. Available at SSRN: https://ssrn.com/abstract=2501577

Edoardo Gaffeo (Contact Author)

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, Trento 38100
Italy

Ivan Petrella

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Damjan Pfajfar

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Emiliano Santoro

Catholic University of the Sacred Heart of Milan - Department of Economics ( email )

20123 Milano
Italy

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