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Monetary Policy with Heterogeneous Households and Financial Frictions

  • Jae Won Lee

    ()

    (Rutgers University, Department of Economics)

This paper presents and estimates a sticky-price model with heterogenous 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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File URL: ftp://snde.rutgers.edu/Rutgers/wp/2010-02.pdf
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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 201002.

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Length: 20 pages
Date of creation: 12 Feb 2010
Date of revision:
Handle: RePEc:rut:rutres:201002
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  8. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
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  19. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  20. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
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  26. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  27. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
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