The Inequality Channel of Monetary Transmission

Abstract

We study optimal monetary policy when inequality is present by introducing agents with different productivities, wages, and financial market accesses into a general equilibrium model with sticky prices. Our main results are: (i) There is a channel from interest rate to inflation throughout inequality; (ii) The welfare-based objective of monetary policy includes inequality stabilization; (iii) Higher levels of financial exclusion are associated to bigger welfare losses and to smaller interest rate variability, providing an alternative explanation to why observed interest rate paths are much less volatile than optimal policies implied by most theoretical models of the monetary transmission mechanism.