Working Paper: CEPR ID: DP7128
Authors: Morten O. Ravn; Stephanie Schmitt-Groh; MartÃn Uribe; Lenno Uuskula
Abstract: This paper introduces deep habits into a sticky-price sticky-wage economy and asks whether the countercyclical markup movements induced by deep habits is helpful for accounting for the dynamic effects of monetary policy shocks. We find that this is the case: When allowing for deep habits, the model can account very precisely for the persistent impact of monetary policy shocks on aggregate consumption and for the impact on inflation that other models have hard a time explaining. In particular, the model can account both for the price puzzle and for inflation persistence. We also show 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. We show that the results are stable over time and are not caused by monetary policy changes.
Keywords: Countercyclical markup; Deep habits; Inflation persistence; Monetary policy shocks; Price puzzle
JEL Codes: E21; E31; E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy shock (E39) | aggregate consumption (E20) |
| monetary policy shock (E39) | inflation (E31) |
| expansionary monetary policy shock (E49) | drop in price level (E31) |
| drop in price level (E31) | delayed rise in inflation (E31) |
| deep habits (D01) | inflation persistence (E31) |
| nominal rigidities (D50) | increase in aggregate consumption (E20) |
| increase in aggregate consumption (E20) | lower markups (D43) |
| lower markups (D43) | affect inflation dynamics (E31) |