Monetary policy with non-homothetic preferences

Cavallari, Lilia (2018): Monetary policy with non-homothetic preferences.

Abstract

This paper studies the role of non-homothetic preferences for monetary policy from both a positive and a normative perspective. It draws on a dynamic stochastic general equilibrium model characterized by preferences with a variable elasticity of substitution among goods and with price adjustment costs à la Rotemberg. These preferences have remarkable implications for monetary policy. Three main results stand out from a comparison of models with an increasing and a constant elasticity. First, an increasing elasticity induces novel intertemporal substitution effects that amplify the propagation of monetary and technology shocks. Second, it weakens the ability of a simple Taylor rule to attain a given level of macroeconomic stabilization. Third, the smallest welfare losses can be attained by stabilizing both inflation and output, in contrast to the prevailing view - based on models with a constant elasticity - that the best thing the monetary authority can do is to control inflation only.

• Item Type: MPRA Paper
• Language: English
• Keywords: non-homothetic preferences; monetary policy; output stabilization; inflation stabilization; Taylor rule; new-Keynesian model; time-varying elasticity.
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E61 - Policy Objectives ; Policy Designs and Consistency ; Policy Coordination

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