When policy should stabilize consumption inequality
Monetary policy in a HANK model, where there is inequality and idiosyncratic consumption risk, can reduce social welfare. As a result, the planner in such models should also aim at reducing consumption inequality, argue Acharaya et al. In this paper, the authors develop and analytical framework which highlights two broad ways in which monetary policy can affect consumption inequality: a) monetary policy may reduce idiosyncratic consumption risk faced by households; and b) it may reduce inequality arising from households’ unequal exposure to aggregate shocks and policy. In their model there is ex-ante inequality which implies that a interest rate hike redistributes from poor debtors to rich savers, as well as unequal distribution of dividends held by a small fraction of households. Fiscal policy is assumed to be slow to adjust to shocks. An important assumption that drives their results is that income risk is countercyclical and not procyclical.
Our main substantive result is that, in the empirically relevant case of countercyclical income risk, this concern for inequality leads monetary policy to put some weight on stabilizing the level of output and to correspondingly reduce the weights on the output gap and the price level relative to RANK. In our calibrated model, the HANK target criterion features roughly equal weight on the level of output and output gap and features a 50% smaller weight on the price level than in RANK.
Optimal Monetary Policy According to HANK
Authors: Sushant Acharya, Edouard Challe, Keshav Dogra
From: Bank of Canada, European University Institute, Federal Reserve Bank of New York
When monetary policy should focus on price stability
Le Grand et al. in this paper introduce a model where incomplete insurance markets for idiosyncratic risks are the main source of agent heterogeneity. They also add nominal frictions, modeled as costly price adjustments. Contrary to Acharaya et al. above, the authors assume a rich set of fiscal tools in the form of linear taxes on capital and labor. They then analyze whether monetary policy should have a redistributional role when fiscal instruments are available and the government can levy resources through linear capital and labor taxes, and when fiscal instruments are missing. In the first case, fiscal policy alone deals with redistribution while monetary policy solely aims at ensuring price stability in each period. In the second case, the authors assume that the capital tax is not time-varying, which leaves a potential role for monetary policy to affect the ex-post real interest rate through inflation:
We find that market incompleteness considerably reduces the volatility of capital tax, but increases the counter-cyclicality of public debt after technology shocks. In the long run (in a timeless perspective), optimal monetary policy has little role for redistribution, even when the capital tax remains fixed along the business cycle.
Should monetary policy care about redistribution? Optimal fiscal and monetary policy with heterogeneous agents
Authors: François Le Grand, Alaïs Martin-Baillon, Xavier Ragot
From: ETH Zurich, SciencesPo
