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Monetary And Fiscal Policy Under Deep Habits

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Executive Summary

Recent work on optimal policy in sticky price models suggests that demand management through fiscal policy adds little to optimal monetary policy. The authors explore this consensus assignment in an economy subject to 'Deep' habits at the level of individual goods where the counter-cyclicality of mark-ups this implies can result in government spending crowding-in private consumption in the short run. They explore the robustness of this mechanism to the existence of price discrimination in the supply of goods to the public and private sectors. They then describe optimal monetary and fiscal policy in this New Keynesian economy subject to the additional externality of deep habits and explore the ability of simple (but potentially nonlinear) policy rules to mimic fully optimal policy.

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