Monetary Policy According to HANK

Abstract

We revisit the transmission mechanism from monetary policy to household consumption in a Heterogeneous Agent New Keynesian (HANK) model. The model yields empirically realistic distributions of wealth and marginal propensities to consume because of two features: uninsurable income shocks and multiple assets with different degrees of liquidity and different returns. In this environment, the indirect effects of an unexpected cut in interest rates, which operate through a general equilibrium increase in labor demand, far outweigh direct effects such as intertemporal substitution. This finding is in stark contrast to small- and medium-scale Representative Agent New Keynesian (RANK) economies, where the substitution channel drives virtually all of the transmission from interest rates to consumption. Failure of Ricardian equivalence implies that, in HANK models, the fiscal reaction to the monetary expansion is a key determinant of the overall size of the macroeconomic response. (JEL D31, E12, E21, E24, E43, E52, E62)