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Uninsured countercyclical risk: an aggregation result and application to optimal monetary policy

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  • R. Anton Braun
  • Tomoyuki Nakajima

Abstract

We consider an incomplete-markets economy with capital accumulation and endogenous labor supply. Individuals face countercyclical idiosyncratic labor and asset risk. We derive conditions under which the aggregate allocations and price system can be found by solving a representative agent problem. This result is applied to analyze the properties of an optimal monetary policy in a new Keynesian economy with uninsured countercyclical individual risk. The optimal monetary policy that emerges from our incomplete-markets economy is the same as the optimal monetary policy in a representative agent model with preference shocks. When price rigidity is the only friction, the optimal monetary policy calls for stabilizing the inflation rate at zero.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2011-04.

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Date of creation: 2011
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Handle: RePEc:fip:fedawp:2011-04

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  1. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2007. "Insurance and Opportunities: A Welfare Analysis of Labor Market Risk," NBER Working Papers 13673, National Bureau of Economic Research, Inc.
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  7. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  8. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc.
  9. Christopher Foote & Kristopher Gerardi & Lorenz Goette & Paul Willen, 2010. "Reducing Foreclosures: No Easy Answers," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 89-138 National Bureau of Economic Research, Inc.
  10. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  11. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
  12. Massimiliano De Santis, 2007. "Individual Consumption Risk and the Welfare Cost of Business Cycles," American Economic Review, American Economic Association, vol. 97(4), pages 1488-1506, September.
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  1. Optimal monetary policy when asset markets are incomplete
    by Christian Zimmermann in NEP-DGE blog on 2010-09-21 20:49:21

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