Leisure Persistence and Liquidity Effect
Abstract
Abstract
In this paper, we investigate whether two-period habit persistence in leisure in the non-linear utility function can generate a persistent drop in nominal interest rate. We consider two models - the basic limited participation model or the leisure model. The results show that the benchmark model can only generate the liquidity effect. The leisure model, however, can generate a persistence drop in nominal interest rate and a persistent increase in the level of employment and output, when there is a positive monetary shock. This is due to sluggishness in decisions on labour supply that prevent the labour market from moving back to the equilibrium immediately after a period of shock.
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