Gini in the Taylor Rule: Should the Fed Care About Inequality?

Abstract

This study investigates whether the Federal Reserve (Fed) should care about inequality. We develop a Heterogeneous Agent New Keynesian (HANK) model, which generates empirically realistic inequalities and business cycle properties observed in the U.S. data. Households in the model economy are subject to the aggregate productivity shock and to the idiosyncratic labor efficiency and preference shocks. In addition, the model distinguishes the extensive and intensive margins of labor supply. We consider the income Gini coefficient in a monetary policy rule to see how an inequality-targeting monetary policy might affect aggregate and disaggregate outcomes, as well as economic welfare. First, we find that a monetary policy rule with an explicit inequality target can be welfare improving, even if inequality becomes volatile. Second, there is an efficiency-equity trade-off: an economy should sacrifice a more volatile output in order to have smaller cyclical variations in its inequality measures. Lastly, when the Fed targets the employment of a specific group of households, it can improve economic welfare and stabilize inequality at the same time.

Keywords: Monetary Policy; Inequality; Welfare; Taylor Rule; Nonconvexity

JEL Classification: E52, D31, D52, D63, J21