Optimal Monetary Policy in a New Keynesian Model with Habits in Consumption

While consumption habits have been utilised as a means of generating a humpshaped output response to monetary policy shocks in sticky-price New Keynesian economies, there is relatively little analysis of the impact of habits (particularly,external habits) on optimal policy. In this paper we consider the implications of external habits for optimal monetary policy, when those habits either exist at the level of the aggregate basket of consumption goods (‘superficial’ 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, which implies that the flex-price equilibrium will no longer be efficient and that policy faces interesting new trade-offs and potential stabilisation biases. Furthermore, the endogenous mark-up behaviour, which emerges when habits are deep, can also significantly affect the optimal policy response to shocks, as well as dramatically affecting the stabilising properties of standard simple rules.

Monetary and Fiscal Policy under Deep Habits

Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. We explore this consensus assignment in an economy subject to ‘deep’ habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. We explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. We then describe optimal monetary and fiscal policy in our New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially nonlinear) policy rules to mimic fully optimal policy.

Spatial Takeoff in the First Industrial Revolution

Using the framework of Desmet and Rossi-Hansberg (forthcoming), we present a model of spatial takeoff that is calibrated using spatially-disaggregated occupational data for England in c.1710. The model predicts changes in the spatial distribution of agricultural and manufacturing employment which match data for c.1817 and 1861. The model also matches a number of aggregate changes that characterise the first industrial revolution. Using counterfactual geographical distributions, we show that the initial concentration of productivity can matter for whether and when an industrial takeoff occurs. Subsidies to innovation in either sector can bring forward the date of takeoff while subsidies to the use of land by manufacturing firms can significantly delay a takeoff because it decreases spatial concentration of activity.

Spatial Takeoff in the First Industrial Revolution

Using the framework of Desmet and Rossi-Hansberg (forthcoming), we present a model of spatial takeoff that is calibrated using spatially-disaggregated occupational data for England in c.1710. The model predicts changes in the spatial distribution of agricultural and manufacturing employment which match data for c.1817 and 1861. The model also matches a number of aggregate changes that characterise the first industrial revolution. Using counterfactual geographical distributions, we show that the initial concentration of productivity can matter for whether and when an industrial takeoff occurs. Subsidies to innovation in either sector can bring forward the date of takeoff while subsidies to the use of land by manufacturing firms can significantly delay a takeoff because it decreases spatial concentration of activity.