Cyclical Inequality in the Cost of Living and Implications for Monetary Policy

Ting Lan, Lerong Li and Minghao Li

No 2025/264, IMF Working Papers from International Monetary Fund

Abstract: This paper documents that households with higher marginal propensities to consume (MPCs) tend to consume goods with more flexible prices. Consequently, they face more cyclical and volatile inflation and experience higher inflation following an expansionary monetary policy shock. We embed this MPC-price stickiness relationship into a tractable multi-sector Two-Agent New Keynesian (TANK) model and analytically demonstrate that it dampens the effectiveness of monetary policy, reducing its efficacy by about 15% relative to a benchmark model with homogeneous consumption baskets. Introducing heterogeneous baskets also generates an inherently inefficient flexible-price equilibrium, which gives rise to a novel trade-off between stabilization and redistribution. The optimal monetary policy therefore differs qualitatively from the standard TANK policy prescription.

Keywords: TANK; HANK; Monetary transmission; Redistribution channel; Price stickiness; Optimal monetary policy; Inequality; Multi-sector model; IMF working papers; expansionary monetary policy shock; ting Lan; sector Two-Agent New Keynesian; consumption basket; Middle East; North Africa; Central Asia (search for similar items in EconPapers)
Pages: 97
Date: 2025-12-19
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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