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Optimal monetary policy with heterogeneous agents

Author

Listed:
  • Galo Nuño

    () (Banco de España)

  • Carlos Thomas

    () (Banco de España)

Abstract

Incomplete markets models with heterogeneous agents are increasingly used for policy analysis. We propose a novel methodology for solving fully dynamic optimal policy problems in models of this kind, both under discretion and commitment. We illustrate our methodology by studying optimal monetary policy in an incomplete-markets model with non-contingent nominal assets and costly inflation. Under discretion, an inflationary bias arises from the central bank’s attempt to redistribute wealth towards debtor households, which have a higher marginal utility of net wealth. Under commitment, this inflationary force is countered over time by the incentive to prevent expectations of future inflation from being priced into new bond issuances; under certain conditions, long run inflation is zero as both effects cancel out asymptotically. For a plausible calibration, we find that the optimal commitment features first-order initial inflation followed by a gradual decline towards its (near zero) long-run value. Welfare losses from discretionary policy are first-order in magnitude, affecting both debtors and creditors.

Suggested Citation

  • Galo Nuño & Carlos Thomas, 2016. "Optimal monetary policy with heterogeneous agents," Working Papers 1624, Banco de España;Working Papers Homepage.
  • Handle: RePEc:bde:wpaper:1624
    as

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    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/16/Fich/dt1624e.pdf
    File Function: First version, October 2016
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    References listed on IDEAS

    as
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal monetary policy with heterogeneous agents
      by Christian Zimmermann in NEP-DGE blog on 2016-11-10 21:12:53

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    Cited by:

    1. Stefano Neri & Giuseppe Ferrero, 2017. "Monetary policy in a low interest rate environment," Questioni di Economia e Finanza (Occasional Papers) 392, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    optimal monetary policy; commitment and discretion; incomplete markets; nominal debt; inflation; redistributive effects; continuous time;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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