New Keynesian Economics with Household and Firm Heterogeneity

Over the past decade, the Heterogeneous-Agent New Keynesian (HANK) literature has shown that household heterogeneity matters for the transmission of monetary and fiscal policy. Drawing on lessons from this literature, we provide a framework for incorporating firm heterogeneity into HANK. Household models use precautionary savings and borrowing constraints to rationalize the high average marginal propensities to consume (MPCs) estimated in empirical work, and these high MPCs activate new transmission channels through after-tax-and-transfer income. Likewise, we develop a benchmark heterogeneous-firm model in which financial frictions can generate high average marginal propensities to invest (MPIs), activating analogous channels through after-tax-and-transfer cash flows. However, unlike for MPCs, we do not have a consensus set of credible estimates of the MPI distribution for a broad sample of firms. We therefore survey the choices that shape the MPI distribution, and so the strength of new policy transmission channels, within models.