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Optimal Monetary Policy When Asset Markets Are Incomplete

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Executive Summary

This paper considers the properties of an optimal monetary policy when households are subject to counter-cyclical uninsured income shocks. The authors develop a tractable incomplete-markets model with Calvo price setting. In the model the welfare cost of business cycles is large when the variance of income shocks is counter-cyclical. Nevertheless, the optimal monetary policy is very similar to the optimal policy that emerges in the representative agent framework and calls for nearly complete stabilization of the price-level.

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