Keeping up with the Joneses and the welfare effects of monetary policy

This paper examines the implications of “keeping up with the Joneses” preferences (jealousy) for the welfare effects of monetary policy. I develop a New Keynesian model, where households are jealous and the central bank follows the Taylor rule. I show that the welfare effects of monetary policy over time depend significantly on the relative strength of the consumption externality caused by jealousy and the monopolistic distortion. When a first-order approximation of the utility function is used, then the main result is the following: If jealousy (the monopolistic distortion) dominates, then a decrease in the interest rate reduces (increases) welfare in the short run, but increases (reduces) welfare in the medium run. However, the use of a second-order approximation changes the sign of the overall welfare effect of monetary policy if the initial level of employment is at the optimal level or just below it.

► This paper introduces keeping up with the Joneses preferences into a monetary policy model.
► The welfare effects of monetary policy depend on jealousy and the monopolistic distortion.
► If jealousy dominates, monetary expansion reduces welfare in the short run.
► If jealousy dominates, monetary expansion increases welfare in the medium run.
► If the monopolistic distortion dominates, the welfare effects are reversed.