Stability Analysis in a Monetary Model With a Varying Intertemporal Elasticity of Substitution

Models dealing with monetary policy are generally based on microfoundations that characterize the behavior of representative agents (households and firms). To explain the representative consumer behavior, it generally assumes a utility function in which the intertemporal elasticity of substitution is constant. Recent literature casts some doubts about the relevance of considering such a constant elasticity value. In this paper, the new Keynesian monetary policy model is explored under the assumption that the elasticity of substitution changes with expectations regarding real economic performance. As a result, one observes that some combinations of parameter values allow for a stable fixed point outcome, while other combinations of parameters are compatible with cycles of various periodicities and even aperiodic fluctuations.