Monetary Policy and Redistribution in Open Economies

Globalization has not integrated households equally into the international goods and financial markets. Because of this uneven international integration, external shocks to the economy can have different impacts across households. How does monetary policy influence these effects?

We build a model of a small open economy featuring uneven international integration across households. Then we analyze the difference between a floating exchange rate regime and a fixed exchange rate regime to study the distributional effects of external shocks on household consumption.

We find that the fixed exchange rate regime amplifies aggregate fluctuations following the external shocks but causes more even consumption responses across households. When considering distributional effects, our quantitative results show the following:

• Under the floating exchange rate regime, taking the increase in foreign demand for domestically produced goods as an example, wages in the tradable goods sector increase significantly. Households working in this sector increase their consumption by much more than those working in the non-tradable goods sector do. Yet this shock also leads to an appreciation of the domestic currency.
• Under the fixed exchange rate regime, the monetary authority lowers the interest rate to avoid such a domestic currency appreciation. This stimulates overall demand, indirectly increases wages in the non-tradable goods sector and reduces the difference in household consumption responses.

These results indicate a trade-off between maintaining overall stabilization and controlling consumption inequality.