Monetary policy with non-Ricardian households

Abstract

This paper analyzes how the presence of non-Ricardian households can alter the dynamics in a New-Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) model. The model is calibrated using data for the US economy. We focus on two key areas. The first is the link between monetary policy and consumption inequality in the presence of non-Ricardian households. We find that a contractionary monetary policy shock increases consumption inequality. Part of this increase is due to a novel government transfer channel. This channel becomes significantly stronger when steady state debt is positive. We also find that because of this link, the presence of non-Ricardian households amplifies the impact of monetary policy on output and inflation. The second area relates to the choice of monetary policy rule. We compare six monetary policy rules, including a new labor income targeting rule. We find that labor income targeting outperforms all other rules for most parameter values. Nominal GDP targeting is better than labor income targeting only when the share of non-Ricardian households is large or when the households exhibit low habit persistence.