Exchange Rates and Monetary Policy with Heterogeneous Agents: Sizing up the Real Income Channel

Adrien Auclert, Matthew Rognlie, Martin Souchier and Ludwig Straub

No 16198, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Introducing heterogeneous households to a New Keynesian small open economy model amplifies the real income channel of exchange rates: the rise in import prices from a depreciation lowers households’ real incomes, and leads them to cut back on spending. When the sum of import and export elasticities is one, this channel is offset by a larger Keynesian multiplier, heterogeneity is irrelevant, and expenditure switching drives the output response. With plausibly lower short-term elasticities, however, the real income channel dominates, and depreciation can be contractionary for output. This weakens monetary transmission and creates a dilemma for policymakers facing capital outflows. Delayed import price pass-through weakens the real income channel, while heterogeneous consumption baskets can strengthen it.

JEL-codes: E52 F32 F41 (search for similar items in EconPapers)
Date: 2021-05
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