Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/189876 
Year of Publication: 
2018
Series/Report no.: 
Staff Report No. 835
Publisher: 
Federal Reserve Bank of New York, New York, NY
Abstract: 
Does market incompleteness radically transform the properties of monetary economies? Using an analytically tractable heterogeneous agent New Keynesian (HANK) model, we show that whether incomplete markets resolve "policy paradoxes" in the representative agent New Keynesian model (RANK) depends primarily on the cyclicality of income risk, rather than incomplete markets per se. Incomplete markets reduce the effectiveness of forward guidance and multipliers in a liquidity trap only if risk is procyclical. Acyclical or countercyclical risk amplifies these puzzles relative to RANK. Cyclicality of risk also affects determinacy: procyclical risk permits determinacy even under an interest rate peg, while countercyclical income risk generates indeterminacy even if the Taylor principle holds. Finally, we uncover a new dimension of monetary-fiscal interaction. Since fiscal policy affects the cyclicality of income risk, it influences the effects of monetary policy even when "passive".
Subjects: 
New Keynesian
incomplete markets
monetary and fiscal policy
determinacy
forward guidance
fiscal multipliers
JEL: 
E21
E30
E52
E62
E63
Document Type: 
Working Paper

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