Inequality, Labour Market Dynamics and the Policy Mix: Insights from a FLANK

This paper investigates whether redistributive fiscal policy can be reconciled with macroeconomic efficiency in a heterogeneous agent economy featuring labour market frictions and monetary policy trade-offs. The paper develops a Finitely-Lived Agent New Keynesian (FLANK) model with search-and-matching frictions and a novel participation margin, where households face a constant probability of permanent exclusion from both labour and financial markets. This structure generates persistent inter-generational and cross-sectional inequality and breaks the Ricardian equivalence through finite lifespans and realistic levels of government debt. The model is used to examine the transitional dynamics following a stylized fiscal expansion in the form of transfers to inactive households. The findings suggest that a dovish monetary stance—characterized by a more muted response to inflation—consistently improves labour market outcomes and mitigates inefficiencies, even when fiscal interventions fail to stimulate aggregate demand. These results imply that accommodative monetary policy can enhance the effectiveness of redistribution in heterogeneous-agent environments.