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Optimal Monetary Policy and Liquidity with Heterogeneous Households

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  • Bilbiie, Florin Ovidiu
  • Ragot, Xavier

Abstract

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.

Suggested Citation

  • Bilbiie, Florin Ovidiu & Ragot, Xavier, 2017. "Optimal Monetary Policy and Liquidity with Heterogeneous Households," CEPR Discussion Papers 11814, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11814
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    References listed on IDEAS

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    More about this item

    Keywords

    heterogenous agents; incomplete markets; limited participation; liquidity constraints; money; optimal (Ramsey) monetary policy;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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