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We show analytically that whether incomplete markets resolve New Keynesian “paradoxes” depends primarily on the cyclicality of income risk, rather than marginal propensity to consume (MPC) heterogeneity. Incomplete markets reduce the effectiveness of forward guidance and multipliers in a liquidity trap only with procyclical risk. Countercyclical risk amplifies these “puzzles.” Procyclical risk permits determinacy under a peg; countercyclical risk generates indeterminacy even under the Taylor principle. MPC heterogeneity leaves determinacy and paradoxes qualitatively unaffected, but can change the sensitivity of GDP to interest rates. By affecting the cyclicality of risk, even “passive” fiscal policy influences the effects of monetary policy.

• E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
• E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
• E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
• E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

• Fiscal policy
• Interest rate risk
• Keynesian economics
• Monetary policy
• Risk
• Taylor's rule

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