Business Cycle Dynamics of a New Keynesian Overlapping Generations Model with Progressive Income Taxation

US is anti-cyclical as in our OLG model.¹⁸

5 Conclusion

We find that the business cycle dynamics of the heterogeneous-agent OLG economy are
very similar to those found in the corresponding representative-agent economy. Our
result is in very good accordance with those of Rfos-Rull (1996). Different from his
study, however, we also consider a non-Walrasian economy with i) sticky prices, ii)
within-generation heterogeneity, iii) quarterly periods, and iv) a monetary shock. The
aggregate variables in our heterogenous-agent OLG model behave almost identical to
those in the corresponding representative-agent model with one exception. In partic-
ular, we find that aggregate hours decrease in response to a positive technology shock
in the OLG model whereas hours increase in the Ramsey model. Thus, heterogeneous
labor may account for the observed negative response of hours to a technology shock
found in a number of empirical papers.

Our study also increases the understanding of the distributional effects of monetary
policy. So far, only the long-run distribution effects of monetary policy have been
analyzed in computable general equilibrium models, as e.g. in Erosa and Ventura
(2002) or Heer and SUssmuth (2006). The short-run effect of unexpected inflation on
the distribution of wealth, to the best of our knowledge, have not received any attention
yet. In this paper, we presented a model framework for the analysis of the distribution
effects of unanticipated inflation. An expansionary monetary shock is found to increase
the inequality of the distribution of factor income, even though only to a small extent.
Due to the tax and transfer system, however, the distribution of disposable income
becomes more equal and gives raise to a more equal distribution of wealth.

Our framework can only be regarded as a first step to a fully-fledged analysis of the
short-run distribution effects of monetary policy. Nevertheless, our model can serve as
a benchmark case for future work that may include a more sophisticated modelling of
the idiosyncratic earnings process and may even allow for a third asset besides money
and capital, namely housing. In particular, we suggested a framework that replicates
the following important channels of monetary policy on the distribution of income

¹⁸Different from us, however, Castaneda et al. (1998) consider annual periods rather than quarterly
periods.

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