Understanding Heterogeneous Agent New Keynesian Models: Insights from a PRANK

In recent years there has been a lot of interest in the effect of income inequality (heterogeneity) on the economy, from both academics and policymakers. Researchers have developed Heterogeneous Agent New Keynesian (HANK) models that incorporate heterogeneity and uninsurable idiosyncratic risk into the New Keynesian models that have become a cornerstone of monetary policy analysis. This research has argued that heterogeneity and idiosyncratic risk change many features of New Keynesian models – the transmission of conventional monetary policy, the forward guidance puzzle, fiscal multipliers, the efficacy of targeted transfers and automatic stabilizers, among others. However, the source of the difference between HANK and representative agent New Keynesian (RANK) models remains unclear. This is because HANK models are typically not analytically tractable, leaving it unclear what exactly is driving the results. To shed light on the macroeconomic consequences of heterogeneity, we develop a stylized HANK model that contains key features present in more complicated HANK models.