Working Paper: NBER ID: w24710
Authors: Anmol Bhandari; David Evans; Mikhail Golosov; Thomas J. Sargent
Abstract: We study optimal monetary and fiscal policy in a model with heterogeneous agents, incomplete markets, and nominal rigidities. We develop numerical techniques to approximate Ramsey plans and apply them to a calibrated economy to compute optimal responses of nominal interest rates and labor tax rates to aggregate shocks. Responses differ qualitatively from those in a representative agent economy and are an order of magnitude larger. Taylor rules poorly approximate the Ramsey optimal nominal interest rate. Conventional price stabilization motives are swamped by an across person insurance motive that arises from heterogeneity and incomplete markets.
Keywords: monetary policy; fiscal policy; inequality; business cycles
JEL Codes: C63; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| positive markup shock (G19) | increase nominal interest rates (E43) |
| increase nominal interest rates (E43) | lower aggregate demand (E19) |
| lower aggregate demand (E19) | counter firms' incentives to raise prices (D43) |
| positive markup shock (G19) | redistribute income from wages to dividends (D33) |
| redistribute income from wages to dividends (D33) | decrease nominal interest rates (E43) |
| decrease nominal interest rates (E43) | boost aggregate demand (E00) |
| decrease nominal interest rates (E43) | boost real wages (J38) |
| positive productivity shock (O49) | lower nominal interest rates (E43) |
| trading frictions (F12) | diminish effectiveness of monetary policy (E52) |
| trading frictions (F12) | increase importance of fiscal instruments (E62) |