1980, 2016). Taking as given the demand function for their labor variety as well as the budget constraint and facing Rotemberg (1982) wage adjustment costs, H-households choose inter-temporal paths for consumption, governments bonds, domestic deposits, international bonds, firm equity shares, and the wage for their labor variety to maximize inter-temporal utility where per-period utility depends on consumption, labor supply, and wealth. Utility from consumption is subject to external habit formation, which helps the model capture the hump-shaped response of consumption to macro shocks as identified in empirical studies (Christiano et al. 2005).

In contrast to that, the L-household’s problem is static. This is because of the assumption that L-households are _hand-to-mouth consumers_ . They do not receive enough income to be able to save. Hence, they hold no wealth and cannot smooth consumption over time. This assumption is empirically accurate and helps the model capture the empirical co-movement of government spending and private consumption (Christiano et al. 2010).

Including wealth in the utility function allows the model to capture precautionary saving motives even at a first-order linear approximation (Michaillat and Saez 2021). To see the implications of this assumption, consider the Euler equation (neglecting productivity growth for the sake of clarity), where _λH,t_ equals marginal consumption utility, _ψA_ is the wealth utility scaling parameter, _RB,t_ is the gross bond return, and Π _Y,t_ is the gross inflation rate. Because saving yields utility by itself, the utility from wealth drives a wedge between the value of a unit of income in _t_ to the expected value that this unit would yield if saved and consumed in _t_ + 1.<sup>6</sup> A critical implication of this modeling choice for T ̈urkiye is that the determinacy of the rationalexpectation equilibrium does not necessitate the _Taylor principle_ : an inflation elasticity of the policy rate greater than one (Schoder 2020).

While government bonds and deposits are assumed to be risk-free, equity shares or international bonds are not. These assets are associated with financial intermediation costs which depend on the net-debt position of the issuer and have the interpretation of risk premia (Christoffel et al. 2008). The equity risk premium on top of risk-free government bonds has been around 5.2% in T ̈urkiye<sup>7</sup> . The international risk premium is assumed to increase with the net-debt position of the RW vis-a-vis T ̈urkiye. With a persistent Turkish current account deficit, the RW has accumulated net assets of around 40% of Turkish GDP (World Bank 2023). Hence, the international risk premium is negative.

> 6As Schoder (2020) explains in detail, this breaks the so-called _classical dichotomy_ at the steady state because it links consumption to the real interest rate. In contrast to conventional Dynamic Stochastic General Equilibrium (DSGE) models, consumption does not drop out from the Euler equation at the steady state. The _natural_ rate of interest is no longer uniquely determined by the Euler equation alone but linked to the real economy through high-skilled consumption.

> 7We derive the risk premium as the difference between stock market returns and 10-year government bond interest rates.

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