Preference Heterogeneity and Optimal Monetary Policy

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Abstract

We study optimal policy design in a monetary model with heterogeneous preferences. In the model 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) based on which households make optimal portfolio choices. We uncover that the two types of preference heterogeneity have distinct
implications for the optimal policy mix of the government. 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 a binding ZLB - and thus potential welfare benefits from allowing negative interest rates on government bonds.
Original languageEnglish
Place of PublicationTilburg
PublisherCentER, Center for Economic Research
Number of pages32
Volume2020.030
Publication statusPublished - 28 Oct 2020

Publication series

NameCentER Discussion Paper
Volume2020-030

Keywords

  • Heterogeneous Consumption Preferences
  • Optimal Policy
  • Zero Lower Bound
  • Negative Interest Rates

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