Heterogeneity and Aggregate Fluctuations: Insights from TANK Models

• Authors: Jordi Galí and Davide Debortoli.
• BSE Working Paper: 112322 | March 24
• Keywords: New Keynesian model , monetary policy , incomplete markets , idiosyncratic income risk , HANK models , representative household
• JEL codes: E32, E52
• New Keynesian model
• monetary policy
• incomplete markets
• idiosyncratic income risk
• HANK models
• representative household

We analyze the merits and limitations of simple tractable New Keynesian models (RANK and TANK) in accounting for the aggregate predictions of Heterogenous Agent New Keynesian models (HANK). By means of comparison of a number of nested HANK models, we isolate the role played by (i) idiosyncratic income risk, (ii) a binding borrowing constraint, and (iii) a portfolio choice between liquid and illiquid assets. We argue that the effects of household heterogeneity can be largely understood looking at the differential behavior of two types of households, hand-to-mouth and unconstrained, We find that a suitably specified and calibrated TANK model (which abstracts from idiosyncratic income risk) captures reasonably well the aggregate implications of household heterogeneity and the main channels through which it operates. That ability increases in the presence of a policy rule that emphasizes inflation stability. In the limiting case of a strict inflation targeting policy, heterogeneity becomes irrelevant for the determination of aggregate output.