Redistributive policy

Monetary policy and redistribution in open economies

Globalization has not integrated households in the same way into international goods and capital markets. Due to this unequal international integration, external shocks on the economy can have different effects on different households. How does monetary policy influence these effects?

We are building a model of a small open economy characterized by unequal international integration between households. Then, we analyze the difference between a floating exchange rate regime and a fixed exchange rate regime to study the distributional effects of external shocks on household consumption.

We find that the fixed exchange rate regime amplifies aggregate fluctuations following external shocks, but causes more homogeneous consumption responses across households. When considering distributional effects, our quantitative results show the following:

  • Under the floating exchange rate regime, if we take the increase in foreign demand for locally produced goods as an example, wages in the tradable goods sector increase significantly. Households working in this sector increase their consumption much more than those working in the non-tradables sector. But this shock also leads to an appreciation of the national currency.
  • Under the fixed exchange rate regime, the monetary authority lowers the interest rate to avoid such appreciation of the national currency. This stimulates aggregate demand, indirectly increases wages in the nontradables sector, and reduces the difference in household consumption responses.

These results indicate a trade-off between maintaining overall stabilization and controlling consumption inequalities.