Household Portfolios, Monetary Policy and Asset Prices

In this paper we study the role of household portfolio rebalancing channel for the aggregate and redistributive effects of monetary policy. The transmission of monetary policy works not only through the usual income and substitution motives, but also through an endogenous portfolio rebalancing effect which generates changes in equilibrium asset prices and a subsequent wealth effect on consumption. In order to jointly study these effects, we introduce an heterogeneous household life-cycle model with multiple assets and combine it with an incomplete markets asset pricing framework. We model monetary policy shocks as a reduction in expected return on safe assets. In equilibrium the reduction in bonds investment prompts a portfolio rebalancing toward riskier assets with a consequent increase in their asset prices and an increase in wealth. According to our model, the positive wealth effect on consumption is offset by an increase in the saving margin induced by the overall reduction in expected return on household portfolio. However, the strength of these two forces notably varies depending on households age. We find that, absent wealth effects, older cohorts reduce consumption while younger cohorts increase their consumption only slightly. The positive wealth-effect increases the consumption response for all cohorts: it strengthens the positive consumption response of the young and more than offsets the reduction in consumption of the old. Nevertheless, the heterogeneity in responses remain the same: the young raise consumption by more than the old