Optimal Monetary and Fiscal Policy with Limited Asset Market Participation

This paper characterises the jointly optimal monetary and fiscal stabilisation policy in a new Keynesian model that allows for consumers who lacking access to asset markets consume their disposable income each period. With full asset market participation, the optimal policy relies entirely on the interest rate to stabilise cost-push shocks and government expenditure is not changed. When asset market participation is limited, there is a case for fiscal stabilisation policy. Active use of public spending raises aggregate welfare because it enables a more balanced distribution of the stabilisation burden across asset-holding and non-asset-holding consumers. The optimal response of government expenditure is sensitive to the financing scheme and whether the policymaker has access to a targeted transfer that can directly redistribute resources between consumers. V. ExtensionsA. CRRA Preferences; B. Targeted Transfers; 4. Impulse responses to a persistent cost-push shock with CRRA utility, tar-geted transfers and equal lump-sum tax financing; C. Alternative Financing Assumptions; 5. Impulse responses to a persistent cost-push shock with goverment debt. .; VI. Conclusion; Appendix; A. Derivation of the Baseline Model; B. Derivation of the Social Welfare Function; C. Solving for Optimal Policy; D. Extensions; E. The 'non-Keynesian' Case; 6. Determinacy for the 'non-Keynesian case; References