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Monetary Policy with Heterogeneous Agents and Borrowing Constraints

Updated on 15 November 2016 Published

Citation

Algan Yann, Ragot Xavier. In: Review of Economic Dynamics Volume 13, Issue 2, April 2010, Pages 295–316.


Abstract

We show that the long-run neutrality of inflation on capital accumulation obtained in complete market models no longer holds when households face binding credit constraints. Borrowing-constrained households are not able to rebalance their financial portfolio when inflation varies, and thus adjust their money holdings differently compared to unconstrained households. This heterogeneity leads to a new precautionary savings motive, which implies that inflation increases capital accumulation. We quantify the importance of this new channel in an incomplete market model where the traditional redistributive effects of inflation are also introduced. We show that this model provides a quantitative rationale for the observed hump-shaped relationship between inflation and capital accumulation.