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Macroeconomic policy and the price of risk

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  • Rohan Kekre

    (University of Chicago)

  • Moritz Lenel

    (University of Chicago)

Abstract

We study the consequences of heterogeneity in risk tolerance in a New Keynesian environment with incomplete markets. When markets are incomplete, the distribution of net worth affects the economy's effective price of risk; when monetary policy is non-neutral, the price of risk affects investment rather than the risk-free rate. Redistribution towards the risk-tolerant or shocks which facilitate greater risk-sharing can reduce the price of risk and raise economic activity. The transmission mechanism of monetary policy operates in part through the endogenous adjustment in the risk premium. Because agents do not internalize the effect of private porfolios on aggregate investment, aggregate demand externalities generate scope for Pareto improvements.

Suggested Citation

  • Rohan Kekre & Moritz Lenel, 2018. "Macroeconomic policy and the price of risk," 2018 Meeting Papers 617, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:617
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