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    Rights statement: c2014 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/3.0/)

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Monetary and fiscal policy under deep habits

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<mark>Journal publication date</mark>03/2015
<mark>Journal</mark>Journal of Economic Dynamics and Control
Volume52
Number of pages20
Pages (from-to)55-74
Publication statusPublished
Early online date26/11/14
Original languageEnglish

Abstract

Allowing habits to be formed at the level of individual goods - deep habits - can radically alter the fiscal policy transmission mechanism as the counter-cyclicality of mark-ups this implies can result in government spending crowding-in rather than crowding-out private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple policy rules to mimic fully optimal policy. We find that the presence of deep habits at empirically estimated levels can imply large externalities that significantly affect the conduct of monetary and tax policy. However, despite the rise in government spending multipliers implied by deep habits, government spending is barely used as a stabilisation tool under the optimal policy.

Bibliographic note

c2014 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/3.0/)