Optimal monetary policy in a New Keynesian model with habits in consumption

In this paper we consider the implications of habits for optimal monetary policy, when those habits either exist at the level of the aggregate basket of consumption goods (‘super…cial’habits) or at the level of individual goods (‘deep’habits: see Ravn, Schmitt-Grohe, and Uribe (2006)). External habits generate an additional distortion in the economy and create new trade-o¤s for optimal policy, as the policy maker does not respond as aggressively to technology shocks in order to avoid exacerbating the habits externality. This can dramatically a¤ect both the parameterization of optimal simple rules, as well as their determinacy properties. These e¤ects are particularly strong when habits are of the deep kind. JEL Codes: E30, E57 and E61 Key Words: consumption habits, nominal inertia, optimal monetary policy Address for correspondence: University of Glasgow, Department of Economics, Adam Smith Building, Glasgow G12 8RT, U.K. E-mail: [email protected], [email protected] and ra¤[email protected]. We thank for comments the associate editor and referee, as well as seminar participants at the University of Strathclyde and the Midwest Macro Meetings 2009 at Indiana University. Ra¤aele Rossi would like to thank the Monetary Policy Strategy Division at the European Central Bank where part of this paper was completed. Campbell Leith would like to thank the ESRC (Grant No.s RES-156-25-003 and RES-062-23-1436) for …nancial assistance.