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Optimal Monetary Policy and Liquidity with Heterogeneous Households

Listed author(s):
  • Bilbiie, Florin Ovidiu
  • Ragot, Xavier

A novel liquidity-insurance motive for monetary policy implies optimal deviations from price stability when heterogeneous households who participate infrequently in financial markets use liquidity to insure idiosyncratic risk. In our tractable sticky-price model that can be solved in closed form, aggregate demand depends on liquidity. The liquidity-insurance motive changes the central bank’s trade-off, which is nevertheless still described by a quadratic approximation to aggregate welfare. Price stability has significant welfare costs because inflation volatility hinders the consumption volatility of constrained households as a side-effect of liquidity-insuring them. Helicopter drops are a better way to achieve this insurance than open-market operations.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 11814.

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Date of creation: Jan 2017
Handle: RePEc:cpr:ceprdp:11814
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