Monetary Policy over the Life Cycle

Abstract

A tighter monetary policy is associated with higher nominal and real interest rates on deposits and loans, weaker performance of equities, lower aggregate investment and consumption, and slower growth in employment and wages. We propose a quantitative lifecycle model that reproduces these responses and find that an asset substitution, or Tobin effect, plays a central role in understanding the responses of stock prices and aggregate investment. We use the model to analyze how a household’s exposure to monetary policy varies with its age and find that monetary policy has important distributional effects. The sign, magnitude, and persistence of household consumption responses depend on age, and the pattern of these responses implies that a tighter monetary policy increases inequality in net worth and consumption. JEL classification: E52, E62, G51, D15