Ivan Petrella, Birbeck College, University of London

"Loss Aversion and the Asymmetric Transmission of Monetary Policy"

Abstract

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.

In line with the prospect theory pioneered by Kahneman and Tversky (1979), losses in consumption loom larger than gains. 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 latter aggregate supply schedule.