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Cristiano Cantore (Bank of England)

6 October 2021 @ 12:00 - 13:15


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6 October 2021
12:00 - 13:15
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Academic Events

“A tail of labor supply and a tale of monetary policy”

We study the effect of monetary policy on households labor supply. Using survey data for the UK and the US we provide evidence of heterogeneous responses. In both countries we find evidence of an inverted labor supply for the left tail of the income distribution. That is, while aggregate hours and real wages decline, individuals at the bottom of the income distribution increase their labor supply following a tightening of the interest rate. We rationalize this using a simple two agents New-Keynesian (TANK) model where for a fraction of households the permanent income hypothesis does not hold (Hand-to-Mouth). We show analytically that to replicate our empirical findings is enough to allow for the income effect to be larger than substitution effect in the Hand-to-Mouth’s preferences. Finally, we use a medium scale TANK model with preference heterogeneity to revisit the implications of inequality on the effectiveness of monetary policy. We find that, contrary to the standard result in TANK models with homogenous preferences, when poor Hand-to-Mouth have an inverted labor supply and preferences are heterogeneous, higher inequality dampens the aggregate effects of monetary policy.

Joint with Filippo Ferroni, Haroon Mumtaz, Angeliki Theophilopoulou