Inequality, Business Cycles, and Monetary-Fiscal Policy
We study optimal monetary and fiscal policy in a model with heterogeneous agents, incomplete markets, and nominal rigidities. We develop numerical techniques to approximate Ramsey plans and apply them to a calibrated economy to compute optimal responses of nominal interest rates and labor tax rates to aggregate shocks. Responses differ qualitatively from those in a representative agent economy and are an order of magnitude larger. Taylor rules poorly approximate the Ramsey optimal nominal interest rate. Conventional price stabilization motives are swamped by an across person insurance motive that arises from heterogeneity and incomplete markets.
We thank Adrien Auclert, Benjamin Moll, and seminar participants at numerous seminars and conferences for helpful comments The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.