DP12601-2 | Heterogeneity, Determinacy, and New Keynesian Puzzles

Publication Date

09/24/2018

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Abstract

Using an analytical HANK model, I find the closed-form conditions for determinacy with interest-rate rules and for curing New Keynesian puzzles. The latter requires (self-insurance against) idiosyncratic uncertainty and that constrained agents' income elasticity to aggregate income be smaller than one. When larger than one, good news on aggregate demand gets compounded, making determinacy less likely and aggravating the puzzles---a Catch-22, because this is when HANK models deliver desirable amplification. A Wicksellian rule of price-level targeting solves this, ensuring determinacy and curing the puzzles even in the amplification region of HANK (including in extensions with cyclical risk).