External Shocks and Monetary Policy Trade-offs in Low-Income Countries

Juan Passadore, Giovanni Sciacovelli, Filiz Unsal and Carlos van Hombeeck

No 2025/204, IMF Working Papers from International Monetary Fund

Abstract: We present an Open Economy HANK model with relevant features for Low-Income Countries (LICs): hand-to-mouth households and a subsistence consumption for tradable goods. With the model calibrated for a representative LIC, we illustrate our broader framework with a shock to external prices. The shock causes a consumption-led recession, an increase in inflation and a drop in real wages. Consumption inequality rises: poor households cannot insure against the shock, unlike richer households who can tap into their wealth. Monetary policy is unable to substantively improve poorer households’ welfare, due to offsetting effects on real wages and labor demand. Simulations of the effects of alternative monetary policy responses on inequality yield similar findings. In this setting, fiscal transfers are a more effective tool for redistribution across households.

Keywords: Monetary Policy; Inequality; Open Economy HANK; Low-income Countries (search for similar items in EconPapers)
Pages: 73
Date: 2025-10-03
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