Working Paper: NBER ID: w28872
Authors: Adrien Auclert; Matthew Rognlie; Martin Souchier; Ludwig Straub
Abstract: 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.
Keywords: exchange rates; monetary policy; heterogeneous agents; real income channel
JEL Codes: E52; F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate depreciation (F31) | reduced real income (E25) |
| reduced real income (E25) | lower consumption (E21) |
| exchange rate depreciation (F31) | lower consumption (E21) |
| exchange rate depreciation (F31) | decrease in output (E23) |
| real income channel dominates (E25) | contractionary effect on output (E62) |
| sticky export prices (P22) | less contractionary output response (E19) |