Price Level and Inflation Dynamics in Heterogeneous Agent Economies

Abstract:

We study steady-state and dynamic equilibria in heterogeneous agent economies with nominal government debt and flexible prices. When governments run a surplus, conditions for price level and inflation determination mirror analogous representative agent economies. However, the quantitative effects differ because of movements in the real interest rate that arise from redistribution of real wealth. When governments run a deficit, steady state equilibria exist with heterogeneous agents -- unlike in a representative agent economy -- provided that the level of deficits is not too large. In these economies the real interest rate is below the growth rate of the economy. With fixed deficits, there are two steady-state equilibria of the real economy and multiple dynamic equilibria. In general, the price level and inflation are not uniquely determined. We describe fiscal and monetary policy rules that deliver uniqueness. We use the framework to illustrate how redistribution amplifies price level increases  in response to fiscal helicopter drops, deficit expansions, loose monetary policy and negative productivity shocks.