Optimal Monetary Policy and Liquidity with Heterogeneous Households

Florin Bilbiie (1, 2) , Xavier Ragot (3, 4, 5)

1 UNIL - Université de Lausanne = University of Lausanne
2 CEPR - Center for Economic Policy Research
3 ECON - Département d'économie (Sciences Po)
4 CNRS - Centre National de la Recherche Scientifique
5 OFCE - Observatoire français des conjonctures économiques (Sciences Po)

A liquidity-insurance motive for monetary policy operates when heterogeneous households use government-provided liquidity (“money”) to insure idiosyncratic risk. In our tractable sticky-price model this changes the central bank's trade-off by adding a linear benefit of insurance in the second-order approximation to aggregate welfare. Inflation volatility hinders the consumption volatility of constrained households as a side-effect of liquidity-insuring them; but price stability has quantitatively significant welfare costs only when monopolistic rents are also large, which indicates a complementarity between imperfect-insurance and New-Keynesian distortions. Helicopter drops are welfare-superior to open-market operations to achieve insurance, but quantitatively their benefit is surprisingly small.

Keywords: Optimal (Ramsey) Monetary Policy; Heterogeneous Households; Incomplete Markets; Money; Inequality; Helicopter Drops

Domains: Humanities and Social Sciences; Economics and Finance

Florin Bilbiie, Xavier Ragot. Optimal Monetary Policy and Liquidity with Heterogeneous Households. Review of Economic Dynamics, 2021, 41, pp.71-95. ⟨10.1016/j.red.2020.10.003⟩. ⟨hal-03501417⟩