International Finance Discussion Papers (IFDP)
December 2002 (Revised March 2005)
Optimal Monetary Policy with Durable and Non-Durable Goods
Christopher J. Erceg and Andrew T. Levin
Abstract:
We document that the durable goods sector is much more interest-sensitive than the non-durables sector, and then investigate the implications of these these sectoral differences for monetary policy. We formulate a two-sector general equilibrium model that is calibrated both to match the sectoral responses to a monetary policy shock derived from our empirical VAR, and to imply an empirically-realistic degree of sectoral output volatility and comovement. While the social welfare function involves sector-specific output gaps and inflation rates, the performance of the optimal policy rule can be closely approximated by a simple rule that targets a weighted average of aggregate wage and price inflation. In contrast, a rule that stabilizes a more narrow measure of final goods price inflation performs poorly in terms of social welfare.
Related Material: Technical Appendix (PDF): This appendix shows how we derive a second order approximation to the social welfare function of our model.
Original version (PDF)Keywords: VAR analysis, DGE models, sectoral disaggregation
PDF: Full Paper
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