Working Paper: CEPR ID: DP12734
Authors: Juan J. Dolado; Gergo Motyovszki; Evi Pappa
Abstract: Contrary to previous beliefs, recent empirical work has found that the effects of monetary policy oninequality are far from modest. In order to improve our understanding of the channels through whichmonetary policy has distributional consequences, we build a New Keynesian model with incomplete assetmarkets, asymmetric search and matching (SAM) frictions across skilled and unskilled workers and,foremost, capital-skill complementarity (CSC) in the production function. Our main finding is that anunexpected monetary easing increases labor income inequality between high and low-skilled workers,and that the interaction between CSC and SAM asymmetry is crucial in delivering this result. This isso since the increase in labor demand driven by a monetary expansion leads to larger wage increasesfor high-skilled workers than for low-skilled workers since the former have smaller matching frictions(SAM-asymmetry channel). Moreover, the increase in capital demand amplifies this wage divergence dueto skilled workers being more complementary to capital than substitutable unskilled workers are (CSCchannel). Strict inflation targeting is often the most successful rule in stabilizing measures of earningsinequality even in the presence of shocks which introduce a trade-off between stabilizing inflation andaggregate demand.
Keywords: monetary policy; search and matching; capital-skill complementarity; inequality
JEL Codes: E24; E25; E52; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unexpected monetary easing (E49) | increase in labor income inequality (F66) |
| expansionary monetary policy shock (E49) | increase in labor demand (J23) |
| increase in labor demand (J23) | larger wage increases for high-skilled workers (J31) |
| increase in labor demand (J23) | smaller wage increases for low-skilled workers (J31) |
| increase in capital demand (E22) | wage divergence between high-skilled and low-skilled workers (J31) |
| interaction of capital-skill complementarity and asymmetric SAM frictions (F16) | increase in inequality following monetary policy shocks (E19) |