Monetary Policy and Heterogeneity: An Analytical Framework

This paper builds THANK, a tractable heterogeneous-agent New Keynesian (HANK) model with two household types – savers and hand-to-mouth agents who move between the two states via a Markov process – that nests the representative-agent (RANK) and two-agent (TANK) models as special cases and admits closed-form solutions for dynamic properties that quantitative HANK models can only compute numerically. Its central object is χ, the elasticity of hand-to-mouth households’ income to aggregate income, which pins down whether income inequality is countercyclical (χ>1) or procyclical (χ<1); the paper shows this single statistic governs whether the model’s aggregate Euler-IS equation exhibits “compounding” or “discounting” relative to the representative-agent benchmark. Countercyclical inequality delivers the aggregate-demand amplification and positive fiscal multipliers that much of the quantitative HANK literature is built to generate, but simultaneously makes the model’s Taylor-rule determinacy condition more stringent than the standard Taylor principle and worsens the forward guidance puzzle – the counterfactual prediction that a monetary policy change further in the future moves consumption today by more than a near-term change; procyclical inequality does the reverse, weakening the Taylor principle’s necessity for determinacy and curing the puzzle. Because amplification and puzzle-curing require opposite cyclicalities of the same χ, the author calls this a “Catch-22” for HANK models. The paper offers two classes of resolution: combining cyclical inequality with a separately modeled cyclical income-risk channel of the opposite sign (empirically, the author reports that U.S. disposable-income inequality was mildly procyclical while income risk was countercyclical in the last two recessions), or switching to policy rules – Wicksellian price-level targeting, or a nominal-debt rule – that restore determinacy regardless of the sign of cyclicality. Finally, solving a Ramsey optimal-policy problem to second order, the paper derives a novel “inequality-stabilization” motive that makes the central bank optimally tolerate more inflation volatility whenever inequality is cyclical, while the cyclicality of idiosyncratic risk itself is shown to be irrelevant to the optimal-policy objective (though not to the interest-rate rule that implements it), because the policy target is the perfect-insurance, no-inequality efficient allocation.

Florin O. Bilbiie | Macro Paper Warehouse

Monetary Policy and Heterogeneity: An Analytical Framework