Discussion Paper Details

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Title: Price stickiness along the income distribution and the effects of monetary policy

Author(s): Javier Cravino, Ting Lan and Andrei A. Levchenko

Publication Date: June 2018

Keyword(s): consumption baskets, Distributional Effects, inflation and monetary policy

Programme Area(s): International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: We document that the prices of the goods consumed by high-income households are more sticky and less volatile than those of the goods consumed by middle-income households. This implies that monetary shocks can have distributional consequences by affecting the relative prices of the goods consumed at different points on the income distribution. We use a Factor-Augmented VAR (FAVAR) model to show that, following a monetary policy shock, the estimated impulse responses of high-income households' consumer price indices are 22% lower than those of the middle-income households. We then evaluate the macroeconomic implications of our empirical findings in a quantitative New-Keynesian model featuring households that are heterogeneous in their income and consumption patterns, and sectors that are heterogeneous in their frequency of price changes. We find that: (i) the distributional consequences of monetary policy shocks are large and similar to those in the FAVAR model, and (ii) greater income inequality increases the effectiveness of monetary policy, although this effect is modest for realistic changes in inequality.

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Bibliographic Reference

Cravino, J, Lan, T and Levchenko, A. 2018. 'Price stickiness along the income distribution and the effects of monetary policy'. London, Centre for Economic Policy Research.