Working Paper: CEPR ID: DP14429
Authors: Sushant Acharya; Edouard Challe; Keshav Dogra
Abstract: We study optimal monetary policy in an analytically tractable Heterogeneous Agent New Keynesian model with rich cross-sectional heterogeneity. Optimal policy differs from that in a representative agent model because monetary policy can affect consumption inequality, both by reducing idiosyncratic consumption risk and by reducing inequality arising from households' unequal exposures to aggregate shocks. Simple target criteria summarize the planner's tradeoff between consumption inequality, productive efficiency and price stability. Mitigating consumption inequality requires putting some weight on stabilizing the level of output, and correspondingly reducing the weights on the output gap and the price level relative to an economy without inequality.
Keywords: New Keynesian model; Incomplete markets; Optimal monetary policy
JEL Codes: E21; E30; E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Optimal monetary policy (E63) | Reduction of consumption inequality (F62) |
| Optimal monetary policy (E63) | Addressing idiosyncratic consumption risk (D11) |
| Monetary policy influences the level of idiosyncratic income risk (E49) | Reduction of consumption inequality (F62) |
| Low interest rates facilitate borrowing (E43) | Insulation of consumption from income shocks (D11) |
| Expansionary monetary policy (E52) | Reduction of consumption risk (D11) |
| Expansionary monetary policy (E52) | Reduction of consumption inequality (F62) |
| Unequal exposure to aggregate shocks (D89) | Complication of optimal policy response (E61) |
| Monetary policy should stabilize output (E63) | Achieving productive efficiency or price stability (E64) |