Precautionary saving and un-anchored expectations

This paper revisits monetary policy in a heterogeneous agents new Keynesian (HANK) model where agents use adaptive learning (AL) in order to form their expectations. Due to the households' finite heterogeneity triggered by idiosyncratic unemployment risk, the model is subject to micro-founded heterogeneous expectations that are not anchored to the rational expectation path. Households experience different histories which has non-trivial consequences on their individual AL processes. In this model, supply shocks generate precautionary saving and possible long-lasting disinflationary traps associated with excess saving. Dovish policies focused on closing the output gap dampen the learning effects which is in contradiction with previously established representative agent under learning results. Price level targeting appears to resolve most of the problem by netter anchoring long-run expectations of future utility flows.