Monetary policy and wealth effects

This paper studies the role of wealth effects in the monetary transmission mechanism in New Keynesian models. We propose a decomposition of consumption that extends the Slutsky equation to a general equilibrium setting. Wealth effects, and their amplification in general equilibrium, explain a large fraction of the consumption and inflation response to changes in nominal interest rates in the standard equilibrium. In RANK, wealth effects are determined, generically, by the revaluation of public debt and the fiscal response to monetary policy. In a medium-scale DSGE model, we find a fiscal response that is several times larger than the response we estimate in the data. Therefore, the model is unable to generate sufficiently strong effects. In an analytical HANK model with positive private debt, private wealth effects amplify the response to monetary policy and improve the quantitative performance of the DSGE model.