DP14429 Optimal Monetary Policy According to HANK

Author(s): Sushant Acharya, Edouard Challe, Keshav Dogra
Publication Date: February 2020
Keyword(s): incomplete markets, New Keynesian Model, Optimal monetary policy
JEL(s): E21, E30, E52, E62, E63
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14429

We study optimal monetary policy in a Heterogenous-Agent New-Keynesian economy. A utilitarian planner seeks to reduce consumption inequality, in addition to stabilizing output gaps and inflation. The planner does so both by reducing income risk faced by households, and by reducing the pass-through from income to consumption risk, trading-off the benefits of lower inequality against productive inefficiency and higher inflation. When income risk is countercyclical, policy curtails the fall in output in recessions to mitigate the increase in inequality. We uncover a new form of time-inconsistency of the Ramsey-plan - the temptation to exploit households' unhedged interest-rate exposure to lower inequality.