We show that in Heterogeneous-Agent New-Keynesian (HANK) economies with countercyclical risk the natural interest rate is endogenous and co-moves with output, leaving the economy susceptible to self-fulfilling fluctuations. Unlike in Representative-Agent New-Keynesian models, the Taylor principle is not sufficient to guarantee uniqueness of equilibrium in HANK if risk is even mildly countercyclical. In fact, we prove that multiple bounded-equilibria exist, no matter how strongly monetary policy responds to changes in inflation. Neither inertial rules nor rules which respond to output-gap fluctuations can resolve this indeterminacy. Instead, to implement a unique equilibrium, policy must stabilize endogenous natural rate fluctuations.
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- Acknowledgements & Disclosure
- The authors would like to thank Keshav Dogra, Ricardo Reis, Gianluca Violante and Shu Lin Wee and participants at the Richmond Fed Core week (March 2024) for helpful comments. This paper was previously circulated with a different title: “Incomplete Markets and Unanchored Expectations”. The views expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the Bank of Canada. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32462
- Published in
- United States of America
