Kyoto University

This paper considers the properties of an optimal monetary policy when house-holds are subject to counter-cyclical uninsured income shocks. We develop a tractable incomplete-markets model with Calvo price setting. In our model the welfare cost of business cycles is large when the variance of income shocks is counter-cyclical. Never-theless, the optimal monetary policy is very similar to the optimal policy that emerges in the representative agent framework and calls for nearly complete stabilization of the price-level