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We explore the role of monetary policy in a world of segmented financial markets, where the agents who trade stocks encounter financial income risk although the rest do not. In such an economy, we study how the monetary authority operates when it aims to maximize total welfare. We find that optimal monetary policy has the novel role of sharing the financial market risk traders face, among all agents in the economy.This finding holds for any concave utility function and is not sensitive to the degree of market segmentation. When risk is shared perfectly in this way, consumption is equalized between the two groups, and agents, if given the choice, would be indifferent * Texas A&M University, 4228 TAMU, College Station, TX 77843, azervou@econmail.tamu.edu, http://econweb.tamu.edu/azervou. I am very grateful to my advisor Stephen Williamson and to Costas Azariadis and James Bullard for their constructive comments and support. I also thank Jacek Suda, the entire Macro Reading Group at Washington University, seminar participants at

We analyze monetary policy in a model with heterogeneous firms, where constrained firms finance operations through external financing and unconstrained firms use internal funds. We show that expansionary monetary policy increases the relative employment of constrained firms, while positive productivity shocks increase that of unconstrained firms. Our results agree with recent empirical findings, emphasizing the role of the monetary authority in reallocating resources across sectors with different financing capabilities. We also show that if the relative productivity of constrained firms is low, then expansionary monetary policy tilts resources towards less productive firms, which decreases the effectiveness of the policy in stimulating aggregate output.

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We study the effects of monetary policy on the labor market across different sectors. We find that the employment response is stronger for firms in manufacturing and construction relative to firms in services. The result also holds within small and large firms. Moreover, within sectors, the employment growth in large firms responds more than it does in small firms after monetary contractions; it does so less after monetary expansions. Finally, we find that the differences in employment growth between small and large firms are greater for firms in the manufacturing and construction sectors compared to those in the service sector.