Time-varying volatility, precautionary saving and monetary policy

Hatcher, M.C. (2011) Time-varying volatility, precautionary saving and monetary policy. Working Paper. Bank of England, Bank of England. Threadneedle Street, London.

Abstract

This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.

• Item Type: Research Reports or Papers (Working Paper)
• Keywords: Time-varying volatility, precautionary saving, monetary policy, DSGE models.
• Status: Published
• Glasgow Author(s) Enlighten ID: Hatcher, Dr Michael
• Authors: Hatcher, M.C.
• Subjects: H Social Sciences > HB Economic Theory; H Social Sciences > HG Finance
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Publisher: Bank of England
• Copyright Holders: Bank of England 2011

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