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A tail of labour supply and a tale of monetary policy

Cristiano Cantore (), Filippo Ferroni (), Hroon Mumtaz () and Angeliki Theophilopoulou ()
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Hroon Mumtaz: Queen Mary, University of London
Angeliki Theophilopoulou: Brunel University London

No 989, Bank of England working papers from Bank of England

Abstract: We study the interaction between monetary policy and labour supply decisions at the household level. We uncover evidence of heterogeneous responses and a strong income effect on labour supply in the left tail of the income distribution, following a monetary policy shock in the US and the UK. That is, while aggregate hours and labour earnings decline, employed individuals at the bottom of the income distribution increase their hours worked in response to an interest rate hike. Moreover, their response is stronger in magnitude relative to other income groups. We rationalize this using a two-agent New-Keynesian (TANK) model where our empirical findings can be replicated with a lower intertemporal elasticity of substitution for the Hand-to-Mouth households. This setup has important implications for the impact of inequality on the transmission of monetary policy. We unveil a novel dampening effect on aggregate demand generated by the Hand-to-Mouth substitution of leisure for consumption following a negative income shock. Therefore we show that the impact of inequality on the transmission mechanism of monetary policy is highly dependent on the different layers of heterogeneity on the household side and the different combinations of nominal and real frictions. More inequality does not necessarily generate a stronger response of aggregate demand after a monetary policy shock.

Keywords: Monetary policy; household survey; FAVARs; TANK; hand to mouth (search for similar items in EconPapers)
JEL-codes: C10 E32 E52 (search for similar items in EconPapers)
Pages: 99 pages
Date: 2022-07-21
New Economics Papers: this item is included in nep-cba, nep-dge, nep-eec and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0989

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