DP10105 Loss Aversion and the Asymmetric Transmission of Monetary Policy

Author(s): Edoardo Gaffeo, Ivan Petrella, Damjan Pfajfar, Emiliano Santoro
Publication Date: August 2014
Keyword(s): asymmetry, business cycle, monetary policy, prospect theory
JEL(s): D03, D11, E32, E42, E52
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10105

There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households? utility depends on consumption deviations from a reference level below which loss aversion is displayed. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and inflation. Contractions face the Central Bank with higher responsiveness of output to interest rate changes, as well as a flatter aggregate supply schedule.