Incomplete markets and households' exposure to interest rate and inflation risk
Subtitle: implications for the monetary policy maker
By: by Andrea Pescatori
Contributors: Federal Reserve Bank of Cleveland
Series: Working paper -- WP07-09; Working paper (Federal Reserve Bank of Cleveland : Online) -- WP07-09.
Publisher: Federal Reserve Bank of Cleveland
Published: 2007
Place of publication: Cleveland, Ohio]
Language: eng
Format: [electronic resource] :
Subjects: Monetary policy; Inflation (Finance); Interest rates
Description: "The present paper studies optimal monetary policy when the representative agent assumption is abandoned and financial wealth heterogeneity across households is introduced. Incomplete markets make households incapable of perfectly insuring against interest rate and inflation risk, creating a trade-off between price level and debt-servicing stabilization. We derive a welfare-based loss function for the policymaker, which includes an additional target related to the cross-sectional distribution of household debt. The extent of the deviation from price stability depends on the initial level of debt dispersion. Using U.S. microdata to calibrate the model, we find an optimal inflation volatility equal to almost 20 percent of the actual volatility of the last 15 years. Finally, the paper studies the design of optimal simple implementable rules. Superinertial rules, which imply a hump-shaped interest rate response to shocks, significantly outperform standard rules."--Federal Reserve Bank of Cleveland  web site.
Notes: Title from PDF file as viewed on 10/25/2007.

Includes bibliographical references.

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