We study optimal monetary and fiscal policies in a New Keynesian model with heterogeneous agents, incomplete markets, and nominal rigidities. Our approach uses small-noise expansions and Fréchet derivatives to approximate equilibria quickly and efficiently. Responses of optimal policies to aggregate shocks differ qualitatively from what they would be in a corresponding representative agent economy and are an order of magnitude larger. A motive to provide insurance that arises from heterogeneity and incomplete markets outweighs price stabilization motives.
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- fiscal policy
- monetary policy
- Sticky prices