Monetary and fiscal policy under deep habits

Leith, C. , Moldovan, I. and Rossi, R. (2015) Monetary and fiscal policy under deep habits. Journal of Economic Dynamics and Control, 52, pp. 55-74. (doi: 10.1016/j.jedc.2014.11.005)

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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.

Item Type:Articles
Glasgow Author(s) Enlighten ID:Leith, Professor Campbell and Moldovan, Dr Ioana and Rossi, Mr Raffaele
Authors: Leith, C., Moldovan, I., and Rossi, R.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Journal of Economic Dynamics and Control
ISSN (Online):1879-1743
Published Online:26 November 2014
Copyright Holders:Copyright © 2014 The Authors
First Published:First published in Journal of Economic Dynamics and Control 52:55-74
Publisher Policy:Reproduced under a Creative Commons License

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Project CodeAward NoProject NamePrincipal InvestigatorFunder's NameFunder RefLead Dept
388121Reinstating fiscal policy as a stabilisation deviceCampbell LeithEconomic & Social Research Council (ESRC)RES-156-25-0003BUS - ECONOMICS