By Martin Kuncl and Alexander Ueberfeldt
We identify a sizable wealth redistribution channel which creates a monetary policy trade-off whereby short-term economic stimulus is followed by persistently lower output over the medium term. This trade-off is stronger in economies with more nominal household debt but weakened by a more aggressive monetary policy stance and underprice-level targeting. Given this trade-off, low-for-long episodes can lead to persistently depressed output. The medium-term implications of the wealth redistribution channel rely on the presence of labor supply heterogeneity, which we show both analytically and in the context of an estimated New Keynesian general equilibrium model with household heterogeneity.
Monetary policy cannot ignore distributional effects any more. Especially when they have aggregate affects, and as this paper shows, long-term aggregate effects. This is making the conduct of policy really difficult. Having more instruments would come in handy…