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Abstract

When inequality is of the essence, optimal monetary policy requires deviations from price stability over the cycle. We build a sticky-price model where aggregate demand depends on liquidity, as heterogeneous consumers hold money in face of uninsurable risk and participate infrequently in .nancial markets. The model is tractable and can be solved in closed form. A novel trade-o. for Ramsey-optimal monetary policy emerges between inequality and standard stabilization objectives. Inequality appears in the "loss function" (a second-order approximation to aggregate welfare). Price stability has signi.cant welfare costs: in.ation volatility is optimal because it insures constrained agents by hindering their consumption volatility.

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