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Optimal monetary policy with durable services: user cost versus purchase price

Ko, Jun-Hyung (2011): Optimal monetary policy with durable services: user cost versus purchase price.

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Abstract

This paper investigates the inflation rate that should be set as the target for the central bank. To this end, we develop a two-sector economy model in the existence of long-lived durables. In contrast to recent studies that have been conducted on how monetary policy can affect the role of durable goods, which examine only the production sector, we introduce a service market. Accordingly, we can endogenously derive the traditional user cost equation and the price-rent ratio. Our main findings are as follows: First, even in cases where both service and production sectors are equally sticky, the user cost is more important than the purchase price, from the perspective of welfare loss. Second, in contrast to the situation in the economy that includes only nondurables, a temporary shock persistently influences output fluctuations. However, this does not mean that welfare loss increases as the degree of durability increases. Third, welfare is found to be a strictly increasing function of durability.

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