Monetary policy and inequality under household heterogeneity and incomplete markets

Motivated by the evidence of the effects of monetary policy on the evolution of inequality, and the importance of insurance mechanisms to deal with idiosyncratic risks, the paper explores the relationship between household inequality and monetary policy in the context of a dynamic stochastic general equilibrium model. In contrast to the traditional approach where the demand-side of the economy is summarised by a single representative agent, the model considers heterogeneous households which face idiosyncratic shocks which they can not fully insure against. The model, which is calibrated using data from Mexico, is able to capture the main features that characterise both the business cycle dynamics, as well as the distribution of income and wealth across households. The results stemming from a series of counterfactual experiments indicate that the the presence of heterogeneity impinges upon the transmission of monetary policy, and that the design of monetary policy has important distributive effects.