Optimal Monetary Policy with Durable and Non-Durable Goods

Abstract

We document that the durable goods sector is much more interest-sensitive than the non-durables sector, and then investigate the implications of these these sectoral differences for monetary policy. We formulate a two-sector general equilibrium model that is calibrated both to match the sectoral responses to a monetary policy shock derived from our empirical VAR, and to imply an empirically-realistic degree of sectoral output volatility and comovement. While the social welfare function involves sector-specific output gaps and inflation rates, the performance of the optimal policy rule can be closely approximated by a simple rule that targets a weighted average of aggregate wage and price inflation. In contrast, a rule that stabilizes a more narrow measure of final goods price inflation performs poorly in terms of social welfare.