MACRO: Optimal Monetary Policy during a Cost-of-Living Crisis; Professor Sterk Vincent (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 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.

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