Cyclical Risk Aversion, Precautionary Saving And Monetary Policy

This paper analyses the conduct of monetary policy in an environment in which cyclical swings in risk appetite affect households' propensity to save. It uses a New Keynesian model featuring external habit formation to show that taking note of precautionary saving motives justifies an accommodative policy bias in the face of persistent, adverse disturbances. Equally, policy should be more restrictive following positive shocks. Monetary policy making in central banks calls for an understanding of how the economy responds to shocks. Economists work with models to achieve this. One type of model that has become increasingly used is the dynamic stochastic general equilibrium framework.

Provided by: Bank of England Topic: CXO Date Added: Apr 2011 Format: PDF

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