Optimal monetary-fiscal policy in a distorted economy with heterogeneous and bounded rational households

01 November 2023 → 31 October 2027
Research Foundation - Flanders (FWO)
Research disciplines
  • Social sciences
    • Macro-based behavioural economics
    • Monetary policy, central banking and the supply of money and credit
    • Prices, business fluctuations and cycles
    • Mathematical and quantitative methods not elsewhere classified
    • General equilibrium and disequilibrium
Heterogeneity and bounded rationality Monetary- and fiscal policy Theoretical macroeconomics
Project description

The recent surge in energy prices has put ample pressure on wallets of economic agents. Principally households in the lower decile of the income distribution are experiencing cutbacks in consumption, since they spend a relatively larger fraction of their income on energy. Consequently, central banks are raising interest rates to tone down inflation, while fiscal governments seek to retain the purchasing power of households. The purpose of this research project is to scrutinize whether these policy responses are in fact the optimal routes monetary- and fiscal authorities can take to alleviate the impact of an energy crisis. I do this analysis in a theoretical framework at the frontier of macroeconomics. To be specific, I construct a New Keynesian model with heterogeneous agents which I then modify to tackle three distinct research questions. First, I study how monetary and fiscal policy in the Eurozone should optimally respond when energy prices increase, in an economy populated by households who differ by wealth state. Second, I extend this framework to examine the efficacy of fiscal tools used in practice by European governments. Finally, I model the heterogeneous households to be boundedly rational, while assuming financial markets to be fully forward looking. This brings about an environment where the so-called ‘forward guidance puzzle’ is solved, in which I investigate optimal monetary-fiscal coordination in the United States when supply side driven inflation arises.