FMM Working Paper

: Income Distribution and the Cost Channel of Monetary Policy: Evidence from Japan, the UK, and the US

This paper assesses the impact of a monetary policy tightening on prices and income distribution. We estimate Structural Vector Autoregressive models for Japan, the UK, and the US over the period 1960Q1-2019Q4. Our findings reveal a cost channel of monetary policy since an increase in interest rates exerts a positive and long-lasting impact on the price level. Furthermore, we highlight the negative effects of restrictive monetary policies on real wages, as price increases are not compensated by an equivalent increase in nominal wages. These findings remain robust across different subperiods and when alternative measures of expectations are incorporated. Finally, by estimating pure shocks from a counterfactual VAR, we decompose the transmission of monetary policy into the demand, distributional, and exchange-rate channels. While the demand channel only partially mitigates the cost channel, the distributional channel amplifies it. By contrast, the exchange-rate channel exerts a disinflationary effect mainly since the 1980s.

Keywords: Monetary policy; Structural vector autoregression; Counterfactual analysis; Price puzzle, Functional income distribution