An aggregate welfare optimizing interest rate rule under heterogeneous expectations

Tim Hagenhoff

No 139, BERG Working Paper Series from Bamberg University, Bamberg Economic Research Group

Abstract: In this paper, I propose an optimal interest rate rule under heterogeneous expectations derived from a welfare criterion that is a second-order approximation of heterogeneous household utility following Di Bartolomeo et al. (2016). Additionally, I explore the agent level of the Branch and McGough (2009) framework in a more detailed fashion which is important as the central bank's welfare criterion depends on consumption inequality. I find that the consumption decision of "rational" agents in Di Bartolomeo et al. (2016) is inconsistent with the higher-order beliefs assumption of Branch and McGough (2009). Hence, consumption rules are derived that are consistent with the micro-foundations of Branch and McGough (2009) including a possible specification of agent's long-run beliefs. Further, the welfare analysis shows that the optimal interest rate rule yields welfare gains that range between 0.1 and 7.1 percent under the considered parameter values relative to a rule that is optimized under a conventional inflation-targeting objective as in Gasteiger (2014). Welfare gains are high when the underlying economy features a high degree of heterogeneity.

Keywords: optimal monetary policy; policy implementation; heterogeneous expectations; inequality (search for similar items in EconPapers)
JEL-codes: D84 E52 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-mac, nep-mon and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bamber:139

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