I study optimal monetary policy in a sticky-price economy wherein households precautionary-save against uninsured, endogenous unemployment risk. In this economy
greater unemployment risk raises desired savings, causing aggregate demand to fall and feed back to greater unemployment risk. This deflationary spiral is constrained
inefficient and calls for an accommodative monetary policy response: after a contractionary aggregate shock the policy rate should be kept significantly lower and for
longer than in the perfect-insurance benchmark. For example, the usual prescription obtained under perfect insurance of a hike in the policy rate in the face of a bad
supply (i.e., productivity or cost-push) shock is easily overturned. The optimal policy breaks the deflationary spiral and takes the dynamics of the imperfect-insurance
economy close to that of the perfect-insurance benchmark. These results are derived in an economy with zero asset supply (zero liquidity) and are thus independent of
any redistributive effect of monetary policy on household wealth.
"Uninsured Unemployment Risk and Optimal Monetary Policy in a Zero-Liquidity Economy."
American Economic Journal: Macroeconomics,
Macroeconomics: Consumption; Saving; Wealth
Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
Price Level; Inflation; Deflation
Household Saving, Borrowing, Debt, and Wealth