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Monetary Policy with Heterogeneous Households and Financial Frictions

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  • Jae Won Lee

    ()
    (Rutgers University, Department of Economics)

Abstract

This paper presents and estimates a sticky-price model with heterogenous households and financial frictions. Frictions in state-contingent asset markets lead to imperfect risk-sharing among households with idiosyncratic labor incomes. I study the impacts of the introduced financial frictions on optimal monetary policy by documenting implications for the central bank's objective function, the equation that characterizes inflation-output gap trade-offs, targeting rules, interest rate rules, and welfare of the economy. Employing the estimated model, the paper argues that the central bank should place a stronger emphasis on stabilizing inflation than it has, and failing to do so can generate nontrivial welfare costs.

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Bibliographic Info

Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 201002.

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Length: 20 pages
Date of creation: 12 Feb 2010
Date of revision:
Handle: RePEc:rut:rutres:201002

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Keywords: monetary policy; financial frictions; heterogeneous households; New Keynesian; nominal rigidities;

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References

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  1. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research 146, National Bank of Belgium.
  2. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
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  10. Vasco Cúrdia & Michael Woodford, 2010. "Conventional and unconventional monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 229-264.
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  23. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
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Cited by:
  1. Scott Davis & Kevin X.D. Huang, 2011. "Optimal monetary policy under financial sector risk," Globalization and Monetary Policy Institute Working Paper 85, Federal Reserve Bank of Dallas.

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