Household heterogeneity and bounded rationality
In this paper, Pfäuti and Seyrich develop a New Keynesian model with household heterogeneity and bounded rationality, in the form of cognitive discounting, that accounts for the following facts: a) Households that exhibit higher marginal propensities to consume are more exposed to monetary policy which is crucial to account for the fact that monetary policy is amplified through indirect general equilibrium effects; b) Under cognitive discounting, households’ expectations underreact to aggregate news which dampens the effects of announced future monetary policy changes and ensures that the model remains determinate under an interest-rate peg.
They use their model to revisit the policy implications of inflationary supply shocks (caused partly by disruptions in production and hence modelled as a total factor productivity (TFP) negative shock) and find a pronounced trade-off between price stability on the one hand, and fiscal and distributional consequences on the other hand.
- When monetary policy fully stabilizes inflation it also closes the output gap independent of the presence of cognitive discounting. The required interest rate response to fully stabilize inflation, however, needs to be much stronger when accounting for cognitive discounting because households expect interest rates to remain elevated for some time.
- When monetary policy follows a standard Taylor rule, the authors show that inflation and the output gap increase considerably due to a novel amplification channel. Both—the underlying heterogeneity and bounded rationality—amplify the inflationary pressure from the supply shock and the two mutually reinforce each other: the positive output gap especially benefits households with higher MPCs increasing the output gap further and, thus, calls for higher interest rates in each period. As households cognitively discount these higher (future) interest rates, this further increases the output gap amplifying the redistribution to high MPCs households and therefore the increase in the output gap until the economy ends up in an equilibrium with a higher output gap and higher inflation. Consumption inequality now decreases as poorer households tend to benefit more from the higher output gap.
A Behavioral Heterogeneous Agent New Keynesian Model
Authors: Oliver Pfäuti, Fabian Seyrich
From: University of Mannheim, Berlin School of Economics
Heterogeneous banks and incomplete markets
In this paper Bellifemine et al. integrate bank heterogeneity and market power to study the transmission of monetary policy. Their framework combines five main features: (i) permanent (“skill”) and stochastic (“luck”) bank returns heterogeneity, (ii) time-varying asset and deposit mark-ups, (iii) endogenous bank default, (iv) deposit insurance, and (v) nominal rigidities. Their setup nests the canonical New Keynesian model with a macro-banking framework, and accommodates heterogeneous mark-ups in both credit and deposit markets, and features both permanent and idiosyncratic bank profitability heterogeneity. Their findings include:
- When calibrated to U.S. bank-level data, the model delivers considerable amplification of transitory monetary policy shocks. They find that much of that amplification comes from the presence of permanent returns heterogeneity.
- There is rich heterogeneity in the responses of banks in different percentiles of the size distribution: in response to a monetary contraction large banks lower their quantities (assets) and credit mark-ups significantly more than small banks.
- Credit market power amplifies the effects of monetary policy on both financial and macroeconomic variables: credit mark-ups, particularly of large intermediaries, fall in response to a contractionary monetary policy shock. Deposit market power, on the other hand, dampens the effects of monetary policy shocks, as deposit mark-ups rise in response to a contractionary monetary policy shock.
HBANK: Monetary Policy with Heterogeneous Banks
Authors: Marco Bellifemine, Rustam Jamilov, Tommaso Monacelli
From: London School of Economics, University of Oxford, Bocconi University
