In this video, Jordi Galí (CREI, UPF and BSE) walks us through the ideas behind his European Research Council (ERC) Advanced Grant project, which seeks to advance our knowledge about the implications of heterogeneity for monetary policy.

The following text is adapted from the video interview with Professor Galí that was conducted in April 2023.

What is missing from traditional macroeconomics models?

During the past few decades, economic fluctuations have been studied by researchers in academia and central banks using frameworks that assume all households are identical. More recently, some researchers have called into question the innocuity of that assumption when it comes to understanding economic fluctuations and their interaction with macroeconomic policies.

This has given rise to a new class of models called “HANK” models, which incorporate heterogeneity across households in otherwise conventional New Keynesian framework with nominal rigidities and hence a role for monetary policy.

What are the advantages of HANK models?

Heterogeneous Agent New Keynesian or “HANK” models allow researchers to address questions that could not be tackled with more traditional models, such as:

• The role of inequality in determining the impact of aggregate shocks on the economy
• The effects of monetary and fiscal interventions on inequality
• The role of inequality in the design of optimal monetary and fiscal policies.

What are the drawbacks of HANK models?

One of the drawbacks of HANK models is that they are complex and cannot be solved with pencil and paper. They need to be solved with numerical methods and the use of a computer.

Because of this, HANK models are difficult to teach in the classroom, and some of the findings may not be intuitive, which can make them hard to convey to policy makers.

What are TANK models?

Two-Agent New Keynesian or “TANK” models are simpler, analytically tractable models that may be good approximations to HANK models.

In TANK models, there are two types of agents. For example, we could design a TANK model in which one type of household has full access to financial markets, while the second type of household has no access to financial markets whatsoever and cannot smooth consumption by borrowing and lending.

Can TANK approximate HANK?

Professor Galí and his colleague Davide Debortoli (ICREA-UPF, CREI and BSE) are currently exploring whether TANK models can provide insights into the properties of richer HANK models.

Their BSE Working Paper (1281), Idiosyncratic Income Risk and Aggregate Fluctuations is an example of ongoing research related to this question and to Galí’s ERC grant.

Idiosyncratic income shocks are just one piece of the macroeconomic picture that Galí and Debortoli are looking at using the new HANK and TANK models. The researchers are also interested in understanding the role played by the presence of borrowing constraints and the role played by different degrees of liquidity of different assets.

This ERC Advanced Grant project is still in progress. As it continues to develop, Professor Galí and his team hope to report some exciting findings using the new macroeconomic frameworks.