Discussion paper

DP11814 Optimal Monetary Policy and Liquidity with Heterogeneous Households

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.


Bilbiie, F and X Ragot (2017), ‘DP11814 Optimal Monetary Policy and Liquidity with Heterogeneous Households‘, CEPR Discussion Paper No. 11814. CEPR Press, Paris & London. https://cepr.org/publications/dp11814