Abstract
We study optimal policy design in a monetary model with heterogeneous preferences. In the model, financial markets are incomplete and households are heterogeneous with respect to their current consumption preferences and discount factors. The government controls the supply of money (liquid) and nominal bonds (illiquid), and households make optimal portfolio choices. We uncover that the two types of preference heterogeneity have distinct distributional consequences and different implications for the optimal monetary policy. While the heterogeneity in current consumption preferences pushes the economy towards a zero lower bound (ZLB) associated with nominal interest rates, the heterogeneity in discount factors moves the economy away from the ZLB. We characterize the optimal policy design and quantify the welfare losses associated with a binding ZLB - and thus also the potential welfare benefits of being able to implement negative interest rates.
Highlights
An extensive quantitative-macro literature studies the role of cross-sectional heterogeneity in explaining consumption and wealth inequality.[1]
(ii) Our analysis reveals that the implications of early and late consumption shocks are quite different from each other with respect to the welfare effects of optimally conducted monetary policy. (iii) we uncover the effects of preference heterogeneity on the ZLB and discuss optimality of negative interest rates
In an OLG framework with shocks to both the marginal utility from current consumption and subjective discount factors, the current paper demonstrates that bonds are essential when current consumption shocks dominate in characterizing preference heterogeneity and analyzes the welfare implications of a ZLB on bond prices
Summary
An extensive quantitative-macro literature studies the role of cross-sectional heterogeneity in explaining consumption and wealth inequality.[1]. In our model we separately incorporate intra-generational heterogeneity with respect to current marginal utility to consume and discount factors shocks into a monetary life-cycle model Based on this framework, we argue that optimal monetary policy needs to influence both the price of liquid (money, i.e. inflation) and illiquid (bonds, i.e. nominal interest rates) assets to achieve an optimal cross-sectional allocation of consumption and wealth over the life-cycle. There are two essential differences between our paper and these two studies: (i) we take a more generalized approach in modeling preference heterogeneity (with respect to incorporating heterogeneity in both current consumption preferences and discount factors), and (ii) our approach allows to uncover the differential impact of the two different margins of preference shocks on co-existence of money and bonds, the ZLB, and optimality of negative interest rates. Our paper is to first in this literature that uncovers a mechanism related to heterogeneity in preferences in justifying the conduct of optimal negative interest rate policies
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