MONETARY POLICY IN A NON-REPRESENTATIVE AGENT ECONOMY: A SURVEY

2020

Governments in EMDEs routinely intervene in agriculture markets to stabilize food prices in the wake of adverse domestic or external shocks. Such interventions typically involve a large increase in the procurement and redistribution of food, which we call a redistributive policy shock. What is the impact of a redistributive policy shock on the sectoral and aggregate dynamics of inflation, and the distribution of consumption amongst rich and poor households? To address this, we build a tractable two-sector (agriculture and manufacturing) two-agent (rich and poor) New Keynesian DSGE model with redistributive policy shocks. We calibrate the model to the Indian economy. We show that for an inflation targeting central bank, consumer heterogeneity matters for whether monetary policy responses to a variety of shocks raises aggregate welfare or not. Our paper contributes to a growing literature on understanding the role of consumer heterogeneity in monetary policy.

Economic Theory, 2011

This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expectations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilibrium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have important implications for business cycle dynamics and for the design of monetary policy. JEL Classifications: G12; G14; D82; D83

2017

How does heterogeneity affect the effectiveness of monetary policy and the properties of economic fluctuations? Using the distinction between constrained and unconstrained households at each point in time, we identify three channels at work in Heterogeneous Agent New Keynesian (HANK) models: (i) changes in the average consumption gap between constrained and unconstrained households, (ii) variations in consumption dispersion within unconstrained households, and (iii) changes in the share of constrained households . We analyze the quantitative importance of each of those factors for output fluctuations in a baseline HANK model. We show that a simple Two-Agent New Keynesian (TANK) model, with a constant share of constrained households and no heterogeneity within either type, approximates reasonably well the implications of a HANK model regarding the effects of aggregate shocks on aggregate output..

SSRN Electronic Journal, 2015

We study the impact of diverse beliefs on conduct of monetary policy. Individual belief is modeled by a state variable that defines an individual's perceived laws of motion. We use a New Keynesian Model that is solved with a quadratic approximation hence individual decisions are quadratic functions. Aggregation renders the belief distribution an aggregate state variable. Although the model has standard technology and policy shocks, diverse expectations change materially standard results about a smooth trade-off between inflation volatility and output volatility. Our main results are summed up as follows: (i) The policy space contains a curve of singularity which is a collection of policy parameters that divides the space into two sub-regions. Some trade-off between output and inflation volatilities exists within each region and some across regions. (ii) The singularity causes volatility of variables to be non monotone in policy parameters. Policymakers cannot assume a more aggressive policy will change outcomes in a predictable manner. (iii) When beliefs are diverse a central bank must also consider the volatility of individual consumption and the related volatility of financial markets. We show aggressive anti-inflation policy increases consumption volatility and aggressive output stabilization policy entails rising inflation volatility. Efficient central bank policy must therefore be moderate. (iv) High optimism about the future typically lowers aggregate output and increases inflation. This "stagflation" effect is stronger the stickier prices are. Policy response is muted since the effects of higher inflation and lower output on interest rates partially cancel each other. Effective policy requires targeting exuberance directly or its effects in asset markets. Central banks already do so with short term interventions. (v) The observed high serial correlation of 0.80 in policy shocks contributes greatly to market volatility and we show that a reduction in persistence of central bank's deviations from a fixed rule will contribute to stability. (vi) Belief dispersion is measured by cross sectional standard deviation of individual beliefs. An increased belief diversity is found to make policy coordination harder and results in lower aggregate output and lower rate of inflation. Bank policy can lower belief dispersion by being more transparent.

SSRN Electronic Journal, 2000

The applied literature on adaptive learning has mostly focused on small, linear models, where the minimum state variable (MSV) solution of the rational expectations equilibrium is used as the agents'perceived law of motion (PLM). In nonlinear models a closed-form MSV solution does not exist and if the model is medium or large-sized there is no univocal linear approximation that is eligible as a candidate PLM. Accordingly, heterogeneous expectations prevail and the process through which agents select (and change) a forecasting model becomes a necessary ingredient of the analysis; moreover, the temporary equilibrium of the learning process no longer converges to the REE, but rather approaches an asymptotic limit that depends on the speci…c form of the expectations equations and hence may be a¤ected by the communication strategies of the monetary policymaker. The objective of this paper is to assess whether in such a model economy, where expectations are mis-speci…ed, heterogeneous and ever changing, the optimal monetary policy exhibits properties that are similar to those found in the literature for small, linear models (e.g. Orphanides and Williams 2007). The main results are the following: (1) expectations heterogeneity is an intrinsic feature of the economy: no PLM succeeds in ruling out all the other forecasting models, though the most inaccurate ones are eventually dismissed; (2) contrary to previous …ndings, the monetary policymaker has no incentive to adopt more in ‡ation-averse policies to keep expectations anchored to targets: too strong a reaction to price shocks increases both in ‡ation and output volatility and tends to make the model unstable and non-learnable; (3) partial transparency seem to enhance somewhat welfare (but fully transparent policies do not), by reducing the slope of the term structure and the variability of long-term interest rates. A higher degree of transparency calls for stronger in ‡ation aversion, so partially recovering the …ndings by Orphanides and Williams.

2019

In the name of food security, many emerging market and developing economies (EMDEs) have enacted more generous food security laws that have led to an increase in the procurement and redistribution of agricultural output. We refer to such changes as a "redistributive policy shock." What is less understand in the literature is the impact of such shocks on monetary policy design. To address this, we build a two-sector (agriculture and manufacturing) two-agent (rich and poor) New Keynesian DSGE model with procurement and redistribution. We show that the economy has steeper AS and AD curves compared to the benchmark economy, leading to a more pronounced impact of supply side and demand side shocks on in‡ation. We calibrate the model to the Indian economy and discuss how the transmission of redistributive policy shocks a¤ects sectoral in‡ation rates, the economy wide in‡ation rate and output gap, sectoral movements in labor, rich and poor agent consumption, and aggregate welfare...

Oxford Economic Papers-new Series, 2004

The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment. The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem. The Banco de España disseminates its main reports and most of its publications via the Internet at the following website: http://www.bde.es. Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

Finance and Economics Discussion Series

We show that makeup strategies, such as average inflation targeting and price-level targeting, can be more effective than a flexible inflationtargeting strategy in overcoming the obstacles created by the effective lower bound in a heterogeneous agent New Keynesian (HANK) model. We also show that the macroeconomic stabilization benefits from such alternative strategies can be substantially larger in a HANK environment than in a representative agent New Keynesian model. We argue that gains in employment outcomes from switching to an alternative strategy would generate disproportionate improvements for historically disadvantaged households and thus have potentially long-lasting effects on the economic well-being of these groups.

RePEc: Research Papers in Economics, 1999

The Working Paper Series seeks to disseminate original research in economics and fi nance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment. The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem. The Banco de España disseminates its main reports and most of its publications via the Internet at the following website: http://www.bde.es. Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

2006

This paper builds a game theoretic model to investi gate credibility in monetary policy when inflation targets are not set by the monetary autho rity and there is uncertainty about the preferences of the central banker. Under reasonable assumptions , the model shows that in countries with greater dispersion in central bankers' preferences, as it i s the case in