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Policy design in a model with swings in risk appetite

De Paoli, Bianca and Zabczyk, Pawel (2012) Policy design in a model with swings in risk appetite. CEP Discussion Papers (CEPDP1170). Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

This paper studies the policy implications of habits and cyclical changes in agents' appetite for risk-taking. To do so, it analyses the non-linear solution of a New Keynesian (NK) model, in which slow-moving habits help match the cyclical properties of risk-premia. Our findings suggest that the presence of habits and swings in risk appetite can materially affect policy prescriptions. As in Ljungqvist and Uhlig (2000), a counter-cyclical fiscal instrument can eliminate habit-related externalities. Alternatively, monetary policy can partially curb the associated overconsumption by responding to risk premia. Specifically, periods in which risk premia are elevated (compressed) merit a looser (tighter) policy stance. However, the associated welfare gains appear quantitatively small.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/_new/publications/series.asp?...
Additional Information: © 2012 The Authors
Divisions: Centre for Economic Performance
Subjects: H Social Sciences > HB Economic Theory
JEL classification: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 07 Aug 2013 14:54
Last Modified: 09 Aug 2020 23:07
URI: http://eprints.lse.ac.uk/id/eprint/51517

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