Working Paper Revision

Optimal Monetary Policy for the Masses

Abstract: We study nominal GDP targeting as optimal monetary policy in a simple and stylized model with a credit market friction. The macroeconomy we study has considerable income inequality, which gives rise to a large private sector credit market. There is an important credit market friction because households participating in the credit market use non-state contingent nominal contracts (NSCNC). We extend previous results in this model by allowing for substantial intra-cohort heterogeneity. The heterogeneity is substantial enough that we can approach measured Gini coefficients for income, financial wealth, and consumption in the U.S. data. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. Optimal monetary policy repairs the distortion caused by the credit market friction and so leaves heterogeneous households supplying their desired amount of labor, a type of "divine coincidence" result. We also further characterize monetary policy in terms of nominal interest rate adjustment.

Keywords: Optimal monetary policy; life cycle economies; heterogeneous households; credit market participation; nominal GDP targeting; non-state contingent nominal contracting; inequality; Gini coefficients;

JEL Classification: E4; E5;

https://doi.org/10.20955/wp.2019.009

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2021-01-20

Number: 2019-009

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