Working Papers

Abstract: I study the effects of cost-push shocks on aggregate demand in a heterogeneous agent New Keynesian model with sticky prices and wages. Using a sequence-space approach, I show that factor income redistribution via variable markups makes supply-side inflation contractionary even under a neutral monetary policy rule. When prices rise, real wages fall due to nominal rigidities, shifting income from workers to firm owners. This reduces aggregate demand whenever the marginal propensity to consume (MPC) out of labor income exceeds the MPC out of profits. The model provides a unified framework for the analysis of different cost-push shocks. I establish a link between markup and cost-push shocks governed by whether the economy is effectively a net importer or exporter of the affected input: shocks are most contractionary when payments flow abroad. Markup shocks are less contractionary because income remains domestic, though redistributed to low-MPC households. When intermediate inputs are entirely domestically owned, the shock is isomorphic to a markup shock. Tariff shocks lie in between, depending on how tariff revenue is spent.

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: 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: 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.