Consumption Heterogeneity and Monetary Policy in an Open Economy

Sihao Chen, Michael Devereux, Kang Shi and Juanyi Xu ()

No 29835, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We explore how consumption heterogeneity affects the international transmission mechanism of monetary shocks and the choice of optimal monetary policy in an open economy. Incorporating two types of agents (Ricardian versus Keynesian) into a standard open economy macro model, we find that there are sizeable ranges of household heterogeneity in which monetary policy become ineffective, but this depends sensitively on the interaction of aggregate demand and relative price effects. We derive the global optimal monetary policy with household heterogeneity under alternative pricing regimes. PPI targeting is still the optimal monetary policy under PCP and can restore the economy to the efficient equilibrium. Under LCP, however, the presence of consumption heterogeneity and currency misalignment implies that CPI inflation targeting is no longer optimal in most cases. Finally, we show that when fiscal instruments such as an import tax and export subsidy are introduced, both currency misalignment and consumption heterogeneity can be eliminated, and even under LCP, PPI targeting is the optimal monetary rule.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 2022-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mon and nep-opm
Note: IFM
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Published as Sihao Chen & Michael B. Devereux & Kang Shi & Juanyi Xu, 2023. "Consumption Heterogeneity and Monetary Policy in an Open Economy," Journal of Monetary Economics, .

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Journal Article: Consumption heterogeneity and monetary policy in an open economy (2023)
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