Habit Formation, Asymmetric Price Adjustment, and Real Exchange Rate Persistence

Research output: Conference Papers (RGC: 31A, 31B, 32, 33)32_Refereed conference paper (no ISBN/ISSN)peer-review

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Author(s)

  • Deokwoo NAM

Related Research Unit(s)

Detail(s)

Original languageEnglish
Publication statusPublished - 23 May 2009

Conference

TitleInaugural Conference 2009
PlaceChina
CityBeijing
Period23 - 24 May 2009

Abstract

This paper studies the effect of habit formation in consumption on the real exchange persistence under monetary policy shocks. Closed economy models of monetary policy have emphasized the ability of habit formation to generate endogenous persistence, which has encouraged the open economy literature to incorporate habit formation into theoretical models to generate greater persistence in the real exchange rate. However, there has not yet been a thorough evaluation of the habit formation effect in the real exchange rate context. By incorporating habit formation into the model of Benigno (2004), it is shown that the habit formation effect depends on the degree of price stickiness assumed within and across countries as well as the design of the monetary policy rule. Habit formation does not affect the dynamics of the real exchange rate under symmetric price adjustment and does not significantly contribute to the persistence of the real exchange rate for more general cases. Furthermore, the contribution of relative price inertia inherent in the open economy to the persistence of the real exchange rate, which is emphasized by Benigno, is also insignificant for plausible parameter values of degrees of price stickiness and most of the real exchange rate persistence relies only on interest rate smoothing so that it is still difficult to generate the observed persistence of the real exchange rate for plausible degrees of price stickiness under monetary shocks.

Citation Format(s)

Habit Formation, Asymmetric Price Adjustment, and Real Exchange Rate Persistence. / NAM, Deokwoo.

2009. Paper presented at Inaugural Conference 2009, Beijing, China.

Research output: Conference Papers (RGC: 31A, 31B, 32, 33)32_Refereed conference paper (no ISBN/ISSN)peer-review