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Optimal Monetary Policy and Liquidity with Heterogeneous Households

Florin Bilbiie and Xavier Ragot ()

No 11814, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: A novel liquidity-insurance motive for monetary policy implies optimal deviations from price stability when heterogeneous households who participate infrequently in financial markets use liquidity to insure idiosyncratic risk. In our tractable sticky-price model that can be solved in closed form, aggregate demand depends on liquidity. The liquidity-insurance motive changes the central bank�s trade-off, which is nevertheless still described by a quadratic approximation to aggregate welfare. Price stability has significant welfare costs because inflation volatility hinders the consumption volatility of constrained households as a side-effect of liquidity-insuring them. Helicopter drops are a better way to achieve this insurance than open-market operations.

Keywords: heterogenous agents; incomplete markets; limited participation; liquidity constraints; money; optimal (Ramsey) monetary policy (search for similar items in EconPapers)
JEL-codes: D14 D31 E21 E3 E4 E5 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2017-01
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