Monetary Policy with Heterogeneous Agents: Insights from TANK models

This paper asks how much of the HANK literature’s message about aggregate behaviour survives in a far simpler model, and answers by first identifying exactly what heterogeneity does. Building on a framework related to Werning (2015), the authors show that a heterogeneous-agent economy departs from its representative-agent counterpart along precisely two dimensions: the difference in average consumption between constrained and unconstrained households at any point in time, and the dispersion of consumption within the subset of unconstrained households. Both appear as “wedges” in an Euler equation for aggregate consumption, so each can be traced in response to any aggregate shock and its quantitative significance measured rather than asserted. A two-agent (TANK) model, with fixed shares of “Ricardian” households who trade financial markets freely and “Keynesian” households who consume current labour income each period, captures the first wedge and ignores the second entirely. The paper’s central finding is that this omission costs little for aggregates: in a canonical HANK calibration the first form of heterogeneity fluctuates substantially with aggregate shocks and is well captured by TANK, while the second remains roughly constant, because unconstrained agents limit their consumption swings by borrowing and saving. Quantitatively, with constant transfers the real-interest-rate elasticity of output on impact is about 70 percent larger in HANK than in RANK, and 64 percent larger in TANK – close agreement – and the two models track each other across alternative transfer rules and borrowing limits, which the authors read as TANK remaining a “good approximation to the richer HANK model” throughout (the widest gap between them is under the loosest borrowing limit, 1.23 against 1.46). Two analytical payoffs follow. Heterogeneity may amplify or dampen the effects of aggregate shocks, depending on the share of constrained agents and the cyclicality of fiscal transfers, but independently of the degree of nominal rigidity or the conduct of monetary policy. And a benevolent central bank’s welfare criterion acquires a third term penalising fluctuations in consumption heterogeneity, which generally cannot be stabilised alongside inflation and the output gap – so the divine coincidence fails. The authors are careful about the size of that last result: for standard calibrations the optimal policy still implies minimal fluctuations in inflation and the output gap, and is “nearly identical” to the representative-agent optimum. The manuscript is marked Preliminary and Incomplete, and its comparisons are restricted throughout to the responses of aggregate variables to aggregate shocks; it makes no claim that TANK reproduces HANK’s distributional detail.

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Monetary Policy with Heterogeneous Agents: Insights from TANK models