We consider an incomplete markets economy with capital accumulation and endogenous
labor supply. Individuals face countercyclical idiosyncratic labor and asset risk. We derive
conditions under which the aggregate allocations and price system can be found by solving a
representative agent problem. This result is applied to analyze the properties of an optimal
monetary policy in a New Keynesian economy with uninsured countercyclical individual
risk. The optimal monetary policy that emerges from our incomplete markets economy is
the same as the optimal monetary policy in a representative agent model with preference
shocks. When price rigidity is the only friction the optimal monetary policy calls for
stabilizing the in
ation rate at zero.
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