Optimal Conventional and Unconventional Monetary Policy Mix

This paper examines the optimal coordination of conventional and unconventional monetary policy tools in an economy with heterogeneous households and mortgage debt. We build a dynamic stochastic general equilibrium (DSGE) model featuring three household types—savers, borrowers, and renters—and include housing investment, long-term fixed-rate mortgages, and a housing production sector. The central bank controls both the short-term interest rate and the long-term rate by adjusting the maturity composition of government bonds. We show that household heterogeneity significantly alters the optimal policy response to macroeconomic shocks. Specifically, after a cost-push shock, optimal policy calls for increasing the short-term rate to contain inflation while simultaneously lowering the long-term rate to ease financial pressures on indebted households and renters. This combination speeds up the recovery of investment and output, stabilizes inflation, but exacerbates consumption inequality. By contrast, in a representative agent model, the optimal response is to raise both rates. Our results underscore the need to consider distributional consequences in monetary policy design and indicate that yield curve control can serve as a valuable tool in heterogeneous economies.