Abstract: Recently many advanced economies have experienced large surges in inflation brought about by higher import prices. I study the transmission of such cost-push shocks in a small open economy using a Heterogeneous Agent New Keynesian (HANK) model. Compared to the canonical Representative Agent New Keynesian (RANK) model, I show that a HANK model with empirically realistic marginal propensities to consume out of income (MPCs) and sticky wages introduces an additional transmission channel: An increase in inflation following a cost-push shock suppresses real wages, which suppress aggregate demand when the MPC out of labor income is greater than the MPC out of profits, highlighting the distributional role of inflation. I then compute the optimal monetary policy response to an increase in import prices. I find that a more hawkish response is optimal in HANK compared to RANK. This is driven by low short-run trade elasticities combined with positive exchange rate pass-through to import prices, implying that an exchange rate appreciation can stabilize inflation and real wages without significantly lowering domestic employment.

Abstract: Introducing heterogeneous households into a New Keynesian model of a small open economy enables the model to fit a set of stylized empirical facts about the transmission of foreign demand shocks. In the absence of a strong labor income effect on consumption, the model counterfactually implies that domestic consumption decreases as the central bank raises the interest rate to curb domestic inflation. With plausible marginal propensities to consume, the model instead produces the observed increase in domestic consumption of both tradeable and non-tradeable goods. This implies that foreign demand shocks are more important for international business-cycle comovement than predicted by existing models. Our findings also have implications for stabilization policies: While monetary policy is well-suited to counteract foreign demand shocks, traditional fiscal policies are inadequate, as they do not provide sufficient stimulus to the tradeable sector. This poses a particular challenge for countries with a fixed exchange rate or in a monetary union.

Abstract: We investigate the role of firm heterogeneity and adjustment costs in the transmission of foreign supply shocks. Our starting point comes from a theoretical insight: If larger firms rely more on easily adjustable inputs, such as materials, then the aggregate output response to changes in the price of these inputs gets amplified relative to a representative firm economy. We next provide empirical evidence that larger firms are indeed more materials-intensive and more responsive to an exogenous foreign shock. We show that a New-Keynesian general equilibrium model with multiple sectors and firm heterogeneity is consistent with these facts. We find that firm heterogeneity, in line with the data, amplifies the response of output and prices to a foreign supply shock, but dampens the labor and GDP responses.

Abstract: We study fiscal multipliers in a small open economy Heterogeneous Agent New-Keynesian (SOE-HANK) model. We provide a set of equivalence results under which the fiscal multiplier in our SOE-HANK model is the same---at any horizon---as in a corresponding representative-agent (RANK) model. Under more general assumptions, the fiscal multipliers in the two models are not equivalent, but remain relatively similar. Yet, we show that the underlying channels driving the fiscal multipliers differ substantially. In particular, consumption increases while net exports tend to decline in the HANK model, whereas the opposite is true in the RANK model.