Optimal Monetary Policy with Heterogeneous Agents: Discretion, Commitment, and Timeless Policy

This paper characterizes optimal monetary policy in a canonical one-asset heterogeneous-agent New Keynesian (HANK) model with wage rigidity – a minimal departure from the representative-agent (RANK) New Keynesian benchmark – and systematically revisits the canonical consensus on optimal monetary policy design under discretion, under commitment, and for short-run stabilization. Under discretion, a utilitarian planner has an incentive to overheat the economy beyond the standard markup-correcting level because lowering interest rates redistributes income toward indebted, high-marginal-utility households; since the public rationally anticipates this, the attempt at stimulus is self-defeating and instead produces inflationary bias in the sense of Barro and Gordon (1983), with the paper’s calibration finding this redistribution channel contributes over four times as much to that bias as the conventional markup distortion. Full commitment restores zero inflation in the long-run stationary equilibrium – because inflation and the nominal rate affect household financial income symmetrically, while only inflation is costly – but the standard Ramsey problem still suffers a “time-0” problem that generates short-run inflationary bias, driven both by the usual forward-looking Phillips curve and, newly in HANK, by each household’s forward-looking value function entering as a planning constraint. To resolve this, the authors extend Marcet and Marimon’s (2019) recursive-multiplier approach to continuous-time heterogeneous-agent economies, defining a “timeless” Ramsey problem augmented with an inflation penalty (now shaped by distributional considerations even in HANK) and a novel distributional penalty that specifically counteracts the planner’s incentive to redistribute toward indebted households; this timeless plan eliminates inflationary bias in both the short and long run and can be implemented either by a discretionary planner confronted with the right penalties or by an appropriately designed inflation target. Finally, characterizing optimal stabilization policy under the timeless Ramsey problem, the paper shows that the classic Divine Coincidence result of RANK models – that inflation and output gaps can always be closed simultaneously absent cost-push shocks – generically fails in HANK even with the correct employment subsidy, because the planner now trades off aggregate stabilization against distributional considerations; a quantitative decomposition traces this departure, in response to demand shocks, specifically to the redistribution wedge. The analysis is conducted in a stylized model with a single financial asset and one particular (interest-rate) redistribution channel, and the authors are explicit that while their qualitative logic should generalize, the exact quantitative conclusions – including the sign of the discretionary inflationary bias – depend on the specific pecuniary channels through which policy redistributes in a given model.

Eduardo Dávila | Macro Paper Warehouse

Optimal Monetary Policy with Heterogeneous Agents: Discretion, Commitment, and Timeless Policy