Discussion paper

DP17080 Monetary Policy with Heterogeneous Risk

We lay out a heteroskedastic New Keynesian model, consistent with the evidence of pervasive cross-sectional variation in individual income risk in micro data. We obtain three main results. First, heterogeneous marginal propensities to consume (MPCs) result from the sensitivity of precautionary savings to realized earnings being heterogeneous across agents. Second, the response of aggregate output to demand shocks hinges crucially on how individual risk co-varies with the degree of individual income cyclicality across the income distribution. Third, the general equilibrium effects of monetary and fiscal policy can be suitably summarized by a set of observable cross-sectional sufficient statistics. Depending on the sign of those statistics, income heteroskedasticity may: (i) dampen or amplify the response of output to demand shocks; (ii) affect the local determinacy of the equilibrium; (iii) attenuate or exacerbate the forward guidance puzzle. We conjecture an incomplete information framework with Bayesian learning as a plausible microfoundation for individual income heteroskedasticity.


Monacelli, T and R Colarieti (2022), ‘DP17080 Monetary Policy with Heterogeneous Risk‘, CEPR Discussion Paper No. 17080. CEPR Press, Paris & London. https://cepr.org/publications/dp17080