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 e¤ects 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 devi-
ations 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 in‡flation. Contractions face the Central Bank with higher responsiveness of
output to interest rate changes, as well as a ‡atter aggregate supply schedule.