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Optimal Monetary Policy when Changes in the Money Supply (or Interest Rates) have Redistributive Effects

Research Project
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01.10.2007
 - 30.09.2008

This project investigates the optimal monetary policy in an environment where changes in the money supply (or interest rates) have redistributive effects. The main questions are: Which agents benefit or lose from an expansion (respectively a contraction) of the money supply? How important are these redistributive effects? Do these effects require a change in how monetary policy is conducted? Do we need to change our assessment of the cost of inflation? In order to study these questions we construct a fundamental model of money with heterogenous agents. Individuals may differ in their rate of time preference, in how much they value leisure, in their trading histories, their cost of accessing financial markets and in their production technology and consumption utility. We investigate the implications of each type of heterogeneity for the optimal monetary policy. In particular, we consider how changes in the money supply (or interest rates) affect real production and welfare in the presence of any of these heterogeneities. Any of these fundamental heterogeneities generate a non-degenerate distribution of money holdings. That is, in equilibrium there will be agents who differ in their money holdings, so that they will be affected differently by the inflation tax. Consequently, monetary policy will have redistributive effects. The main focus of our project is to analyze these effects and to identify the consequences for the optimal monetary policy. There is virtually no theoretical or empirical work available that provide answers to these questions. The main reason is that almost all theoretical models of money and monetary policy are based on a representative agent. Evidently, in a representative agent framework monetary policy can have no redistributive effects by definition. Only recently, there have been some attempts to close this gap. This project contributes to this rapidly growing branch of the literature. Eventually, our results may have a profound impact on how monetary policy is viewed to affect different individuals and social classes. We intend to publish our results in leading economic journals, and to present our papers at conferences and seminars. In this way, we hope to encourage more young researchers in Switzerland to participate in the development of this promising research.

Publications

Berentsen, Aleksander and Strub, Carlo (2009) ‘Central bank design with heterogeneous agents’, European economic review, 53(2), pp. 139–152. Available at: https://doi.org/10.1016/j.euroecorev.2008.03.007.

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Members (1)

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Aleksander Berentsen

Principal Investigator