Optimal Monetary Policy during a Cost-of-Living Crisis
Professor Vincent Sterk
Department of Economics
University College London
Abstract:
How should monetary policy react to sectoral shocks in a world where consumption baskets and demand elasticities vary across households? We present a multi-sector New Keynesian model with generalized, non-homothetic preferences and inequality. The output gap is governed by a Marginal Consumer Price Index (MCPI), rather than the regular CPI. Policy trade-offs are shaped by two novel wedges in the New-Keynesian Phillips Curve (NKPC). Analytical results and quantitative simulations show that, following a negative shock to necessity sectors, the NKPC is shifted upward, increasing CPI inflation but decreasing the output gap. We find that the optimal policy response is relatively accommodative.
