Time-varying volatility, precautionary saving and monetary policy

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 27 October 2011

Working Paper No. 440
By Michael Hatcher

This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.

PDFTime-varying volatility, precautionary saving and monetary policy

Other papers

Give your feedback

Was this page useful?
Yes
No
Add your details...