Deep habits and the dynamic effects of monetary policy shocks

Ravn, Morten O., Schmitt-Grohe, Stephanie, Uribe, Martin, and Uuskula, Lenno-Deep habits and the dynamic effects of monetary policy shocks We introduce deep habits into a sticky-price sticky-wage economy and examine the resulting models ability to account for the impact of monetary policy shocks. The deep habits mechanism gives rise to countercyclical markup movements even when prices are flexible and interacts with nominal rigidities in interesting ways. Key parameters are estimated using a limited information approach. The deep habits model can account very precisely for the persistent impact of monetary policy shocks on aggregate consumption and for both the price puzzle and inflation persistence. A key insight is that the deep habits mechanism and nominal rigidities are complementary: the deep habits model can account for the dynamic effects of monetary policy shock at low to moderate levels of nominal rigidities. The results are shown to be stable over time and not caused by monetary policy changes. J. Japanese Int. Economies 24 (2) (2010) 236-258. Department of Economics, University College London, Drayton House, Gordon Street, London SW1E 6BT, UK: Department of Economics, Columbia University, 1109A International Affairs Building, New York, NY 10027, USA; Department of Economics, European University Institute, Villa San Paolo, Via della Piazzoula 43, Florence 50103, May; CEPR, 53-56 Great Sutton Street, London EV1V ODG, UK; NBER, 1050 Massachusetts Ave., Cambridge, MA 02138, USA. (C) 2009 Elsevier Inc. All rights reserved.