Effect of a cost channel on monetary policy transmission in a behavioral new Keynesian model

Abstract This paper explores the role of the cost channel in a behavioral New Keynesian model where households and firms have different degrees of cognitive discounting. Our findings are summarized as follows. First, we demonstrate how the degree of cognitive discounting significantly affects the determinacy condition through the cost channel model. Second, a high degree of cognitive discounting attenuates the response of inflation to a monetary tightening shock, and the cost channel amplifies this effect. Third, the degree of cognitive discounting significantly impacts the effect of the cost channel on the design of optimal monetary policy.