Jen-Jen La’o, Professor, Columbia University Economics
Abstract: We study optimal monetary policy in a dynamic, general equilibrium economy with heterogeneous agents and a motive for redistribution. All heterogeneity is ex-ante: workers differ in state-contingent skill levels, yet markets are complete. The fiscal authority has access to a uniform, state-contingent lump-sum tax (or transfer), but linear taxes are restricted to be non-state-contingent. We derive conditions under which implementing flexible-price allocations is optimal. We show that such allocations are not optimal when the labor income distribution varies with the business cycle, and in such cases, optimal monetary policy implies a countercyclical mark-up.