Uninsured Unemployment Risk and Optimal Monetary Policy in a Zero-Liquidity Economy

Abstract

I study optimal monetary policy in a sticky-price economy wherein households precautionary-save against uninsured, endogenous unemployment risk. In this economy greater unemployment risk raises desired savings, causing aggregate demand to fall and feed back to greater unemployment risk. This deflationary spiral is constrained inefficient and calls for an accommodative monetary policy response: after a contractionary aggregate shock the policy rate should be kept significantly lower and for longer than in the perfect-insurance benchmark. For example, the usual prescription obtained under perfect insurance of a hike in the policy rate in the face of a bad supply (i.e., productivity or cost-push) shock is easily overturned. The optimal policy breaks the deflationary spiral and takes the dynamics of the imperfect-insurance economy close to that of the perfect-insurance benchmark. These results are derived in an economy with zero asset supply (zero liquidity) and are thus independent of any redistributive effect of monetary policy on household wealth. (JEL E21, E24, E31, E52, G51)

Optimal monetary policy and liquidity with heterogeneous households

“…First, households participating in …nancial markets have a high income and join a family where risk is pooled-an extension of Lucas (1990), also used more recently by i.a. Challe et al (2017). Second, a family head chooses the allocations of all households (including those not participating in …nancial markets who have a low income), under liquidity contraints.…”

Taking off into the Wind: Unemployment Risk and State-Dependent Government Spending Multipliers

“…24 To capture these characteristics, we set the replacement rate to h = 0.4 and impose a separation rate of s = 0.05 -twice the benchmark value, along with a targeted unemployment rate of u = 0.059, which yields a job-finding probability f 0.8 -almost four times the benchmark value. These numbers are almost identical to those used by Challe (2018), who targets the U.S. labor market at a quarterly frequency.…”

“…Our framework shares several features with those developed by Ravn and Sterk (2016), Challe (2018), and Gornemann, Kuester, and Nakajima (2016), who, however, focus on the implications of unemployment risk for the conduct of monetary policy. 4 Importantly, we relax the assumption of zero net aggregate supply of bonds, made by Ravn and Sterk (2016) and Challe (2018), which leads to a degenerate wealth distribution in equilibrium, such that changes in unemployment risk and precautionary saving are only accommodated by changes in the equilibrium real interest rate. Instead, in our economy, the supply of bonds varies endogenously, giving rise to a non-degenerate distribution of households along government bond holdings, and introducing an additional source of income heterogeneity across households.…”

Workers, Capitalists, and the Government: Fiscal Policy and Income (re)distribution

“…Finally, our analysis explicitly abstract from another important feature of HANK models: time-varying precautionary savings behavior due to idiosyncratic risk. Challe (2020) and Acharya and Dogra (2020) develop tractable models capturing this mechanism.…”