Optimal Monetary Policy with Durable and Non-Durable Goods

33 Pages Posted: 9 Mar 2003

See all articles by Christopher J. Erceg

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Andrew T. Levin

affiliation not provided to SSRN

Date Written: December 2002

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 impact on non-durable expenditures. We then proceed to formulate and calibrate a two-sector dynamic general equilibrium model that roughly matches the impluse 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.

Keywords: VAR analysis, DGE models, sectoral disaggregation

JEL Classification: E31, E32, E52

Suggested Citation

Erceg, Christopher J. and Levin, Andrew, Optimal Monetary Policy with Durable and Non-Durable Goods (December 2002). Available at SSRN: https://ssrn.com/abstract=366585 or http://dx.doi.org/10.2139/ssrn.366585

Christopher J. Erceg (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Andrew Levin

affiliation not provided to SSRN

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