Exchange Rates and Monetary Policy with Heterogeneous Agents: Sizing up the Real Income Channel
Adrien Auclert (),
Matthew Rognlie (),
Martin Souchier and
No 28872, NBER Working Papers from National Bureau of Economic Research, Inc
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.
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