A1 Refereed original research article in a scientific journal
Revisiting intertemporal elasticity of substitution in a sticky price model
Authors: Kilponen Juha, Vilmunen Jouko, Vähämaa Oskari
Publisher: Elsevier
Publication year: 2022
Journal: Journal of Economic Dynamics and Control
Journal name in source: JOURNAL OF ECONOMIC DYNAMICS & CONTROL
Journal acronym: J ECON DYN CONTROL
Article number: 104498
Volume: 144
Number of pages: 18
ISSN: 0165-1889
eISSN: 1879-1743
DOI: https://doi.org/10.1016/j.jedc.2022.104498(external)
Web address : https://doi.org/10.1016/j.jedc.2022.104498(external)
Abstract
Macroeconomic models typically assume additively separable preferences where consumption enters the utility function in a logarithmic form. This restriction implies that consumption growth is highly sensitive to movements in real interest rates, which in turn implies an unrealistically steep demand curve and intertemporal trade-off. We re-estimate the stylized New Keynesian Model with US data using King et al. (1988) preferences with and without habits and show that the equilibrium real interest rate elasticity of output is in the range of 0.05-0.20 in the US. Such low real interest rate elasticity is better in line with the empirical consumption Euler equation literature and implies relatively weak transmission of monetary policy to output and inflation. (C) 2022 Elsevier B.V. All rights reserved.
Macroeconomic models typically assume additively separable preferences where consumption enters the utility function in a logarithmic form. This restriction implies that consumption growth is highly sensitive to movements in real interest rates, which in turn implies an unrealistically steep demand curve and intertemporal trade-off. We re-estimate the stylized New Keynesian Model with US data using King et al. (1988) preferences with and without habits and show that the equilibrium real interest rate elasticity of output is in the range of 0.05-0.20 in the US. Such low real interest rate elasticity is better in line with the empirical consumption Euler equation literature and implies relatively weak transmission of monetary policy to output and inflation. (C) 2022 Elsevier B.V. All rights reserved.
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