Abstract

We study optimal monetary policy in a heterogeneous agent new Keynesian economy. A
utilitarian planner seeks to reduce consumption inequality, in addition to stabilizing output gaps
and inflation. The planner does so both by reducing income risk faced by households, and by
reducing the pass-through from income to consumption risk, trading off the benefits of lower
inequality against productive inefficiency and higher inflation. When income risk is
countercyclical, policy curtails the fall in output in recessions to mitigate the increase in
inequality. We uncover a new form of time inconsistency of the Ramsey plan—the temptation to
exploit households' unhedged interest rate exposure to lower inequality

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