Implications of habit formation for optimal monetary policy

Jeffery D. Amato and Thomas Laubach

No 2001-58, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We study the implications for optimal monetary policy of introducing habit formation in consumption into a general equilibrium model with sticky prices. Habit formation affects the model's endogenous dynamics through its effects on both aggregate demand and households' supply of output. We show that the objective of monetary policy consistent with welfare maximization includes output stabilization, as well as inflation and output gap stabilization. We find that the variance of output increases under optimal policy, even though it acquires a higher implicit weight in the welfare function. We also find that a simple interest rate rule nearly achieves the welfare-optimal allocation, regardless of the degree of habit formation. In this rule, the optimal responses to inflation and the lagged interest rate are both declining in the size of the habit, although super-inertial policies remain optimal.

Keywords: Monetary policy; Interest rates (search for similar items in EconPapers)
Date: 2001
New Economics Papers: this item is included in nep-mon and nep-pke
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Citations: View citations in EconPapers (18)

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Related works:
Journal Article: Implications of habit formation for optimal monetary policy (2004)
Working Paper: Implications of habit formation for optimal monetary policy (2002)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2001-58

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