Limited Participation, Capital Accumulation and Optimal Monetary Policy

Motivated by recent empirical findings on money demand, the paper presents a general equilibrium model where agents have limited participation in financial markets and use money to smooth consumption. In such setup, investment is not optimal because only a fraction of households participate in financial markets in each period. Optimal monetary policy substantially increases welfare by changing investment decisions over the business cycle, but adverse redistributive effects limit the scope for an active monetary policy. Recent developments in the heterogeneous-agents literature are used to develop a tractable framework with aggregate shocks, where optimal monetary policy can be analyzed