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Optimal Policy with Heterogeneous Agents

Paper Session

Saturday, Jan. 7, 2023 10:15 AM - 12:15 PM (CST)

New Orleans Marriott, Bonaparte
Hosted By: Society for Economic Dynamics
  • Chair: Matthew Rognlie, Northwestern University

Optimal Policy with Heterogeneous Agents: A Sequence-Space Approach

Adrien Auclert
,
Stanford University
Michael Cai
,
Northwestern University
Matthew Rognlie
,
Northwestern University
Ludwig Straub
,
Harvard University

Abstract

We provide a new sequence-space approach to solve for both the steady state and transitional dynamics of optimal policy in models with heterogeneous agents. For the steady state, we find that both existence and non-existence are possible under standard calibrations, and discuss how to ensure existence. For transitional dynamics, we extend the timeless perspective to one-off policy reforms, and characterize the optimal mix of fiscal and monetary policy as stabilization tools.

Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy

Beatriz González
,
Bank of Spain
Galo Nuño
,
Bank of Spain
Dominik Thaler
,
European Central Bank
Silvia Albrizio
,
International Monetary Fund

Abstract

We analyze monetary policy in a New Keynesian model with heterogeneous firms and financial frictions. Firms differ in their productivity and net worth and face collateral constraints that cause capital misallocation. TFP endogenously depends on the time-varying distribution of firms. A monetary expansion increases the investment of constrained firms with a high marginal revenue product of capital (MRPK) relatively more than that of low-MRPK ones, crowding out the latter and increasing TFP. We provide empirical evidence based on Spanish granular data supporting this mechanism. This has important implications for optimal monetary policy design. First, a central bank without pre-commitments engineers an unexpected monetary expansion to increase TFP in the medium run. Second, the divine coincidence holds after a demand shock. Third, if nominal rates are constrained by the zero lower bound, the optimal policy prescribes that rates should remain low for much longer than under complete markets.

Optimal Monetary Policy According to HANK

Sushant Acharya
,
Bank of Canada
Edouard Challe
,
European University Institute
Keshav Dogra
,
Federal Reserve Bank of New York

Abstract

We study optimal monetary policy in an analytically tractable Heterogeneous Agent New Keynesian model with rich cross-sectional heterogeneity. Optimal policy differs from a Representative Agent benchmark because monetary policy can affect consumption inequality, by stabilizing consumption risk arising from both idiosyncratic shocks and unequal exposures to aggregate shocks. The tradeoff between consumption inequality, productive efficiency and price stability is summarized in a simple linear-quadratic problem yielding interpretable target criteria. Stabilizing consumption inequality requires putting some weight on stabilizing the level of output, and correspondingly reducing the weights on the output gap and price level relative to the representative agent benchmark.

Optimal Monetary Policy with Heterogeneous Agents: A Timeless Ramsey Approach

Eduardo Dávila
,
Yale University
Andreas Schaab
,
Columbia University

Abstract

This paper characterizes optimal monetary policy in a canonical heterogeneous-agent New Keynesian (“HANK”) model with wage rigidity. We develop a timeless Ramsey approach to study optimal long-run policy, time inconsistency, and optimal stabilization policy, as well as optimal policy under discretion. We show that i) zero inflation is the optimal long-run policy in our baseline model, ii) the standard inflation target is augmented by distributional considerations, iii) monetary policy in HANK faces a second source of time inconsistency that requires a new distributional target, iv) Divine Coincidence fails in heterogeneous-agent economies due to pecuniary externalities even in the absence of cost-push shocks, and v) there are gains from commitment relative to discretion even in the absence of cost-push shocks. We compute optimal stabilization policy in response to productivity, demand, and cost-push shocks both non-linearly and using sequence-space perturbation methods, which we extend to Ramsey problems and welfare analysis.
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
  • E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook