Heterogeneity and the Equitable Rate of Interest

The equitable rate of interest represents a benchmark to evaluate the cross-sectional effects\r\nof monetary policy. I define it as the real rate of interest that minimizes the welfare losses\r\nassociated to cross-sectional heterogeneity, under flexible prices. In a large class of models,\r\nit can be expressed as the payoff of a suitably chosen portfolio.\r\nIn a Two-Agent New Keynesian model the deviations of the optimal policy prescription, relative to a Representative-Agent benchmark, can be traced back to the equitable rate gap:\r\nthe difference between prevailing real rates and the equitable rate. This parallels the way in\r\nwhich the natural rate is the reference stick to evaluate the stance of monetary policy with\r\nregards to aggregate stabilization. Indeed, the difference between the natural rate and the\r\nequitable rate marks the tradeoff between aggregate and cross-sectional stabilization, faced\r\nby a welfare-maximizing policymaker.