Optimal Portfolio Choices and the Fiscal Channel of Monetary Policy

Abstract

The main objective of this paper is to analyze the impact of countercyclical fiscal rules on monetary policy transmission channels. Using a model with portfolio heterogeneity and aggregate uncertainty as a basis, it is shown that unexpected shocks on nominal interest rate induce effects on the composition of income across the wealth distribution. In this context, a fiscal policy rule aimed at reducing the procyclicality of government spending in recessionary contexts through debt issuance (i.e., a countercyclical fiscal rule) helps to mitigate these distributional effects. This result is associated with the fact that the increase in the supply of bonds generates changes in their expected return –impacting households’ consumption and portfolio decisions–, which alters the transmission of monetary shocks on income. On the other hand, the conclusions presented in this paper lay the foundations for future analyses aimed at studying the trade–off between monetary policy stabilization and its distributional consequences.