Inequality and Optimal Monetary Policy in the Open Economy

Title: Inequality and Optimal Monetary Policy in the Open Economy (with Sushant Acharya)

Abstract: We study optimal monetary and exchange-rate policy in a tractable Small Open Economy Heterogeneous-Agent New Keynesian (SOE-HANK) model in which households face uninsurable idiosyncratic risk. We derive conditions under which a SOE-HANK divine coincidence prevails – a generalisation to HANK of the open-economy divine coincidence result in Galı and Monacelli (2005). Away from this benchmark, fluctuations in consumption inequality generate new tradeoffs for monetary policy, relative to those arising under complete markets. With countercyclical consumption risk, monetary policy puts additional weight on stabilizing output and the real exchange rate relative to the Representative-Agent benchmark.