Heterogeneity and monetary policy

Abstract

In a simple environment with heterogeneous agents, we demonstrate that the central bank delivers a higher inflation rate than when population is homogeneous. This tendency to choose a higher level of inflation than efficiency dictates is due to the efficiency-vs-equity trade-off that the central bank faces in this heterogeneous economy: up to a certain level, inflation decreases inequality. Optimal delegation involves appointing a central bank that puts a higher weight on the utility of the high-productivity workers than society does. This effect of delegation that improves the macroeconomic outcome disappears as homogeneity is restored. However, the inflation level under optimal delegation does not reach the efficiency level.