Deep Habits, Nominal Rigidities and Interest Rate Rules

This paper explores how the introduction of deep habits in a standard new-Keynesian model affects the properties of widely used interest rate rules. In particular, an interest rate rule satisfying the Taylor principle is no longer a su±cient condition to guarantee determinacy. Including interest rate smoothing and a response to output deviations from steady state significantly improve the regions of determinacy. However, under all the simple interest rate rules considered here with contemporaneous variables, determinacy is not guaranteed for very high degree of deep habits. The intuition behind these findings is tied to how deep habits give rise to counter-cyclical markups, a property that makes it an appealing feature in the study of demand shocks.