DP17741 Heterogeneous Effects of Monetary Policy across Income and Race: the Labour Mobility Channel
Labour supply choices–participation and allocation–are key links from monetary policy to wage inequality. Empirically, we find that monetary policy disproportionally affects separations for low-income workers and hiring rates for high-income workers; the wages of the bottom earners who remain in the market in turn grow faster due to a selection effect. We build a model with uninsurable income risk, skill-heterogeneity, participation and occupational choices and nominal rigidities that replicate these empirical findings because transition probabilities depend on wealth and earnings making monetary transmission heterogeneous. With a monetary contraction, bottom earners are more likely to exit the labour market as their earnings decline on impact by more, and those who remain see wages grow by more because the pool of workers improves and a decline in overall labour supply. Thus, wage inequality declines. The selection is stronger when the dispersion of skills is higher, when a stronger selection channel tames the output-inflation trade-off.