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Monetary Policy with Heterogeneous Households and Financial Frictions

  • Jae Won Lee

    (Rutgers University-New Brunswick)

This paper presents and estimates a sticky-price model with heterogeneous households and financial frictions. Frictions in state-contingent asset markets lead to imperfect risk-sharing among households with idiosyncratic labor incomes. I study the impacts of the introduced financial frictions on optimal monetary policy by documenting implications for the central bank's objective function, the equation that characterizes inflation-output gap trade-offs, targeting rules, interest rate rules, and welfare of the economy. Employing the estimated model, the paper argues that the central bank should place a stronger emphasis on stabilizing inflation than it has, and failing to do so can generate nontrivial welfare costs.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 1021.

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Date of creation: 2010
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Handle: RePEc:red:sed010:1021
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