Sushant Acharya | Macro Paper Warehouse

Self-Fulfilling Fluctuations in HANK Economies

Thu, 01 Jan 2026 00:00:00 +0000

Research question and motivation: A central tenet of monetary policy is that aggressively raising nominal rates more than one-for-one with inflation (the Taylor principle) nips self-fulfilling inflationary beliefs in the bud. That logic is built on Representative-Agent New Keynesian (RANK) models that abstract from inequality and incomplete markets. Acharya and Benhabib ask whether this central tenet survives in Heterogeneous-Agent New Keynesian (HANK) economies where idiosyncratic income risk is countercyclical, and they answer in the negative: no matter how aggressively monetary policy responds to inflation, such economies remain susceptible to self-fulfilling fluctuations (“endogenous demand shocks”).

Optimal Monetary Policy According to HANK

This paper studies optimal monetary policy in an analytically tractable heterogeneous-agent New Keynesian (HANK) economy in which households face uninsurable idiosyncratic labor-disutility shocks and can only self-insure through a riskless bond and hours worked. Using CARA preferences and normally distributed shocks – a device the authors also used in earlier work – the model aggregates linearly, so that the entire cross-sectional distribution of consumption collapses to a single sufficient statistic (Sigma_t) that a utilitarian Ramsey planner weighs alongside the standard output-gap and inflation objectives. The paper shows that monetary policy affects this inequality statistic through up to four distinct channels – income risk, self-insurance, unhedged interest rate exposure (URE), and (with nominal debt) the Fisher channel – and derives closed-form optimal policy rules that nest the representative-agent (RANK) case. When income risk is countercyclical (the empirically relevant case), optimal policy curtails the fall in output during recessions more than RANK would, tolerating higher inflation because doing so also limits the associated rise in consumption inequality. The paper’s most novel result is normative and methodological rather than purely quantitative: because a surprise rate cut can redistribute from savers to debtors given existing wealth dispersion, but an anticipated one cannot, the Ramsey-optimal plan is time-inconsistent in a genuinely new way – a benevolent planner who could re-optimize would always want to engineer one more surprise cut. These results are derived under the baseline assumption of real (inflation-indexed) household debt; Section 6 shows they survive, and are reinforced, when debt is nominal and the Fisher channel is reintroduced.

Understanding HANK: Insights From a PRANK

This paper builds a fully analytically solvable heterogeneous-agent New Keynesian (HANK) model – infinitely lived households with CARA utility facing normally distributed, uninsurable idiosyncratic labor-income risk and access to a single riskless bond – to isolate which feature of market incompleteness actually drives HANK models away from their representative-agent (RANK) counterparts. The central result is that the answer is the cyclicality of idiosyncratic income risk, not marginal-propensity-to-consume (MPC) heterogeneity from hand-to-mouth households, which the paper shows has a logically distinct and generally smaller effect. Procyclical income risk (rising in booms) makes the aggregate Euler equation “discounted,” weakens or eliminates the forward-guidance puzzle documented by Del Negro, Giannoni and Patterson (2015) and McKay, Nakamura and Steinsson (2015), and makes the Taylor principle unnecessary for determinacy – even a nominal interest-rate peg can be determinate. Countercyclical income risk does the reverse: it makes the Euler equation “explosive,” amplifies the forward-guidance puzzle, requires a strictly stronger-than-standard Taylor rule for determinacy, and inflates government-spending multipliers in a liquidity trap. Because fiscal policy – specifically, how tax and transfer rates and dividend distribution vary with the business cycle – determines the cyclicality of idiosyncratic income risk even when it is “passive” in the fiscal-theory-of-the-price-level sense (it always adjusts to ensure government solvency), the paper concludes that ordinary tax-and-transfer design is a first-order, and previously underappreciated, determinant of how monetary policy transmits in an incomplete-markets economy. Separately, the paper shows MPC heterogeneity does change the contemporaneous interest-rate sensitivity of aggregate demand (amplifying it when hand-to-mouth income is more cyclically sensitive than aggregate income, dampening it when less so, following Bilbiie 2008), and can reinforce or partly undo the effect of risk cyclicality on the forward-guidance puzzle, but the paper’s Taylor-principle and determinacy results are shown to depend on risk cyclicality alone, unaffected by the degree of MPC heterogeneity.