INTEREST RATE RULES AND EQUILIBRIUM STABILITY UNDER DEEP HABITS | Academic Article individual record
abstract

This paper studies the determinacy of equilibrium in a new Keynesian model with deep habits under different interest rate rules. The main finding is that an interest rate rule satisfying the Taylor principle is no longer a sufficient condition to guarantee determinacy. Including interest rate smoothing and a response to output deviations from steady state significantly enlarges the regions of determinacy. However, under all the simple interest rate rules considered, determinacy is not guaranteed for a very high degree of deep habits. Deep habits give rise to countercyclical markups, which is in line with empirical evidence and makes them an appealing feature in the study of demand shocks. The countercyclicality of markups also leads to multiple equilibria because of self-fulfilling expectations for a high degree of deep habit formation. © 2013 Cambridge University Press.

author list (cited authors)
Zubairy, S.
publication date
2014
published in
keywords
  • Taylor Principle
  • Deep Habits
  • Interest Rate Rules
  • Sticky Prices
citation count

12