This note provides a nontechnical summary of a research paper (Bullard and DiCecio [2021, Classical policy benchmarks for economies with substantial inequality, Federal Reserve Bank of St. Louis, unpublished manuscript]) that I presented as the NIESR 2021 Dow Lecture on 9 February 2021. In the paper, we construct a simple benchmark macroeconomic model with substantial heterogeneity among households, enough to generate empirically plausible Gini coefficients for the distributions of consumption, income and financial wealth. The model includes aggregate shocks as well as both permanent and temporary idiosyncratic uncertainties. Four policymakers—implementing monetary, fiscal, labour market and education policies—act in concert to achieve a first-best allocation of resources. We argue that the roles of these policymaker types are ‘classic’ and match up well with observed policymaker roles in OECD countries. We regard this simple economy as a benchmark for the study of other aspects of the interaction between policy and inequality.

Benhabib and Farmer show that in a laissez-faire one-sector real business cycle model under aggregate increasing returns, under sufficiently high degrees of productive externality, the demand-side effect in the labor market triggered by agents' expectations about the economy's future outweighs the supply-side effect, making agents' expectations become self-fulfilling. This paper analytically demonstrates that the conduct of monetary policy under nominal gross domestic product (GDP) targeting reinforces the supply-side effect in the labor market, thereby making belief-driven aggregate fluctuations more difficult to occur. This reinforcement effect on labor supply is absent under nominal consumption targeting and inflation targeting. Hence, under these two monetary regimes, the necessary and sufficient conditions for the economy to display equilibrium indeterminacy and sunspot fluctuations are identical to those in Benhabib and Farmer's laissez-faire economy. The results are robust to an endogenous growth extension of the model, implying that targeting the nominal GDP growth rate is more desirable than targeting the nominal consumption growth rate or the inflation rate in terms of macroeconomic stability.

Although a number of economists have tried to revive the idea of nominal GDP targeting since the financial crisis of 2008, very little has been said about how this objective might be achieved in practice. This paper adopts and extends a strategy first outlined by Holbrook Working and later employed in the P-Star model. It presents a series of theoretical and empirical results to argue that Divisia monetary aggregates can be controlled by the Federal Reserve and that the trend velocities of these aggregates exhibit the stability required to make long-run targeting of a nominal objective feasible.