Monetary Policy According to HANK Greg Kaplan Ben Moll Gianluca - PowerPoint PPT Presentation

Monetary Policy According to HANK Greg Kaplan Ben Moll Gianluca Violante European Central Bank, 5 November 2015

• Three building blocks 1. Uninsurable idiosyncratic income risk 2. Nominal price rigidities 3. Assets with different degrees of liquidity • Today: Transmission mechanism for conventional monetary policy HANK: Heterogeneous Agent New Keynesian models • Framework for quantitative analysis of aggregate shocks and macroeconomic policy 1

• Today: Transmission mechanism for conventional monetary policy HANK: Heterogeneous Agent New Keynesian models • Framework for quantitative analysis of aggregate shocks and macroeconomic policy • Three building blocks 1. Uninsurable idiosyncratic income risk 2. Nominal price rigidities 3. Assets with different degrees of liquidity 1

HANK: Heterogeneous Agent New Keynesian models • Framework for quantitative analysis of aggregate shocks and macroeconomic policy • Three building blocks 1. Uninsurable idiosyncratic income risk 2. Nominal price rigidities 3. Assets with different degrees of liquidity • Today: Transmission mechanism for conventional monetary policy 1

• Consumption response to a change in real rates • Textbook Representative Agent New Keynesian (RANK) model • Direct response is everything • Pure intertemporal substitution (RA Euler Equation) Why HANK? • VAR evidence: sizable effects of monetary shocks on C 2

• Textbook Representative Agent New Keynesian (RANK) model • Direct response is everything • Pure intertemporal substitution (RA Euler Equation) Why HANK? • VAR evidence: sizable effects of monetary shocks on C • Consumption response to a change in real rates dC ∂C d Y ∂C dr = + × ∂r dr ∂Y ���� ���� ���� direct response to r direct response to Y GE effect on inc 2

Why HANK? • VAR evidence: sizable effects of monetary shocks on C • Consumption response to a change in real rates dC ∂C d Y ∂C dr = + × ∂r dr ∂Y ���� ���� ���� direct response to r GE effect on inc direct response to Y � �� � � �� � >95% <5% • Textbook Representative Agent New Keynesian (RANK) model • Direct response ∂C ∂r is everything • Pure intertemporal substitution (RA Euler Equation) 2

Why HANK? • Both theory and data suggest ∂C ∂r is small 1. Macro: empirically, small sensitivity of C to r 2. Micro: many hand-to-mouth hh for whom ∂c ∂r ≈ 0 3. Micro: many wealthy hh for whom ∂c ∂r < 0 • Implication: RANK parameterized to be consistent with data ⇒ small effects of monetary policy shocks on C • Reconcile small effects in NK model with sizable effects in data? 3

direct response to direct response to inc GE effect on inc RANK: >95% RANK: <5% HANK: <25% HANK: >75% • HANK generates as large as in data even though is small. Why HANK? • HANK ingredients deliver realistic distributions of ∂c ∂r and ∂c ∂Y 4

Why HANK? • HANK ingredients deliver realistic distributions of ∂c ∂r and ∂c ∂Y dC ∂C ∂C d Y dr = + × ∂r ∂Y dr ���� ���� ���� direct response to r direct response to inc GE effect on inc � �� � � �� � RANK: >95% RANK: <5% HANK: <25% HANK: >75% • HANK generates dC dr as large as in data even though ∂C ∂r is small. 4

Why does this matter? • Much more nuanced view of monetary policy • HANK: to understand C response to monetary policy, watch labor demand, investment • Not true in RANK model 5

Literature and contribution Combine two workhorses of modern macroeconomics: 1. New Keynesian models with limited heterogeneity Campell-Mankiw, Gali-LopezSalido-Valles, Iacoviello, Challe-Matheron-Ragot-Rubio-Ramirez • micro-foundation of spender-saver behavior 2. Bewley models with sticky prices Oh-Reis, Guerrieri-Lorenzoni, Ravn-Sterk, Gornemann-Kuester-Nakajima, DenHaan-Rendal-Riegler, Bayer-Luetticke-Pham-Tjaden, McKay-Reis, McKay-Nakamura-Steinsson, Huo-RiosRull, Werning, Luetticke • assets with different liquidity Kaplan-Violante • new view of individual earnings risk Guvenen-Karahan-Ozkan-Song • Continuous time approach Achdou-Han-Lasry-Lions-Moll 6

Building blocks Households • Face uninsured idiosyncratic labor income risk • Consume and supply labor • Hold two assets: liquid and illiquid Firms • Monopolistic competition for intermediate producers • Quadratic price adjustment costs à la Rotemberg (1982) Assets • Liquid assets: nominal return set by monetary policy • Illiquid assets: real return determined by profitability of capital 7

Households ∫ ∞ e − ( ρ + λ ) t u ( c t , ℓ t , h t ) dt s.t. max E 0 { c t ,ℓ t ,c h t ,d t } t ≥ 0 0 ˙ b t = r b ( b t ) b t + (1 − ξ ) wz t ℓ t − T ( wz t ℓ t ) − d t − χ ( d t , a t ) − c t − c h t a t = r a (1 − ω ) a t + ξwz t ℓ t + d t ˙ h t = c h t + νωa t z t = some Markov process c h b t ≥ − b, a t ≥ 0 , t ≥ 0 • c t : non-durable consumption • d t : illiquid deposits • b t : liquid assets • χ : transaction cost function • z t : individual productivity • T : labor income tax • ℓ t : hours worked t : rentals • c h • a t : illiquid assets • h t : housing services • ξ : direct deposits 8

Households ∫ ∞ e − ( ρ + λ ) t u ( c t , ℓ t , h t ) dt s.t. max E 0 { c t ,ℓ t ,c h t ,d t } t ≥ 0 0 ˙ b t = r b ( b t ) b t + (1 − ξ ) wz t ℓ t − T ( wz t ℓ t ) − d t − χ ( d t , a t ) − c t − c h t a t = r a (1 − ω ) a t + ξwz t ℓ t + d t ˙ h t = c h t + νωa t z t = some Markov process c h b t ≥ − b, a t ≥ 0 , t ≥ 0 • c t : non-durable consumption • d t : illiquid deposits ( ≷ 0 ) • b t : liquid assets • χ : transaction cost function • z t : individual productivity • T : labor income tax • ℓ t : hours worked t : rentals • c h • a t : illiquid assets • h t : housing services • ξ : direct deposits 8

Households ∫ ∞ e − ( ρ + λ ) t u ( c t , ℓ t , h t ) dt s.t. max E 0 { c t ,ℓ t ,c h t ,d t } t ≥ 0 0 ˙ b t = r b ( b t ) b t + (1 − ξ ) wz t ℓ t − T ( wz t ℓ t ) − d t − χ ( d t , a t ) − c t − c h t a t = r a (1 − ω ) a t + ξwz t ℓ t + d t ˙ h t = c h t + νωa t z t = some Markov process c h b t ≥ − b, a t ≥ 0 , t ≥ 0 • c t : non-durable consumption • d t : illiquid deposits ( ≷ 0 ) • b t : liquid assets • χ : transaction cost function • z t : individual productivity • T : labor income tax • ℓ t : hours worked t : rentals • c h • a t : illiquid assets • h t : housing services • ξ : direct deposits 8

Households ∫ ∞ e − ( ρ + λ ) t u ( c t , ℓ t , h t ) dt s.t. max E 0 { c t ,ℓ t ,c h t ,d t } t ≥ 0 0 ˙ b t = r b ( b t ) b t + (1 − ξ ) wz t ℓ t − T ( wz t ℓ t ) − d t − χ ( d t , a t ) − c t − c h t a t = r a (1 − ω ) a t + ξwz t ℓ t d t ˙ h t = c h t + νωa t z t = some Markov process c h b t ≥ − b, a t ≥ 0 , t ≥ 0 • c t : non-durable consumption • d t : illiquid deposits ( ≷ 0 ) • b t : liquid assets • χ : transaction cost function • z t : individual productivity • T : labor income tax • ℓ t : hours worked t : rentals • c h • a t : illiquid assets • h t : housing services • ξ : direct deposits 8

• Recursive solution of hh problem consists of: 1. consumption policy function 2. deposit policy function 3. labor supply policy function joint distribution of households Households • Adjustment cost function � � χ 2 d � � χ ( d, a ) = χ 0 | d | + χ 1 a � � a � � • Linear component implies inaction region • Convex component implies finite deposit rates 9

Households • Adjustment cost function � � χ 2 d � � χ ( d, a ) = χ 0 | d | + χ 1 a � � a � � • Linear component implies inaction region • Convex component implies finite deposit rates • Recursive solution of hh problem consists of: 1. consumption policy function c ( a, b, z ; w, r a , r b ) 2. deposit policy function d ( a, b, z ; w, r a , r b ) 3. labor supply policy function ℓ ( a, b, z ; w, r a , r b ) ⇒ joint distribution of households µ ( da, db, dz ; w, r a , r b ) 9

Monopolistically competitive intermediate goods producers: • Technology: • Set prices subject to quadratic adjustment costs: Exact NK Phillips curve: Firms Representative final goods producer: (∫ 1 ε ) ε − 1 ( p j ) − ε ε − 1 Y = y ε dj ⇒ y j = Y j P 0 10

Exact NK Phillips curve: Firms Representative final goods producer: (∫ 1 ε ) ε − 1 ( p j ) − ε ε − 1 Y = y ε dj ⇒ y j = Y j P 0 Monopolistically competitive intermediate goods producers: ( r ) α ( w ) 1 − α • Technology: y j = Zk α j n 1 − α m = 1 ⇒ 1 − α j Z α • Set prices subject to quadratic adjustment costs: ( ˙ ( ˙ ) ) 2 p = θ p Θ Y p 2 p 10

Firms Representative final goods producer: (∫ 1 ε ) ε − 1 ( p j ) − ε ε − 1 Y = y ε dj ⇒ y j = Y j P 0 Monopolistically competitive intermediate goods producers: ( r ) α ( w ) 1 − α • Technology: y j = Zk α j n 1 − α m = 1 ⇒ 1 − α j Z α • Set prices subject to quadratic adjustment costs: ( ˙ ( ˙ ) ) 2 p = θ p Θ Y p 2 p Exact NK Phillips curve: ( ) ˙ Y π = ε m = ε − 1 ρ − θ ( m − ¯ m ) + ˙ π, ¯ ε Y 10