DP11814 Optimal Monetary Policy and Liquidity with Heterogeneous Households
Author(s): | Florin Ovidiu Bilbiie, Xavier Ragot |
Publication Date: | January 2017 |
Date Revised: | July 2017 |
Keyword(s): | heterogenous agents, incomplete markets, limited participation, liquidity constraints, money, optimal (Ramsey) monetary policy |
JEL(s): | D14, D31, E21, E3, E4, E5 |
Programme Areas: | Monetary Economics and Fluctuations |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=11814 |
A novel liquidity-insurance motive for monetary policy implies optimal deviations from price stability when heterogeneous households who participate infrequently in financial markets use liquidity to insure idiosyncratic risk. In our tractable sticky-price model that can be solved in closed form, aggregate demand depends on liquidity. The liquidity-insurance motive changes the central bank?s trade-off, which is nevertheless still described by a quadratic approximation to aggregate welfare. Price stability has significant welfare costs because inflation volatility hinders the consumption volatility of constrained households as a side-effect of liquidity-insuring them. Helicopter drops are a better way to achieve this insurance than open-market operations.