Home production and sticky price models: Implications for monetary policy

• I embed home production into a New Keynesian model.
• The model amplifies impulse responses to monetary and technology shocks.
• I show that strict inflation targeting implements the constrained first best.
• Deviations from this rule yield quantitatively large welfare losses.

I analyze the consequences of including home production in a New Keynesian model with staggered price setting. Home production amplifies responses to technology and monetary policy shocks. Compared to a model without home production, the model generates close to twice the output response to a monetary policy shock. I consider the implications of several nominal interest rate rules and show that a traditional Taylor rule lacks its usual attractive properties. Alternatively, strict inflation targeting implements the constrained efficient allocation.