Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/315013 
Year of Publication: 
2025
Series/Report no.: 
Discussion Papers No. 25-02
Publisher: 
University of Bern, Department of Economics, Bern
Abstract: 
This paper analyzes the monetary policy trade-off between defending purchasing power of consumers and keeping moderate debt cost for borrowers, in the framework of a heterogeneous agent New Keynesian open economy hit by a foreign energy price shock. Raising the interest rate indeed combats the loss in purchasing power due to the energy shock through a real exchange rate appreciation: however, this comes at the expense of higher interest payments for debtors. The trade-off can be resolved by adopting a milder interest rate policy during the crisis in exchange for a prolonged contraction beyond the energy shock time span. This interest rate smoothing approach allows to still experience a real appreciation today, while spreading the impact on debt costs more evenly over time. This policy counterfactual is analyzed in a quantitative model of the UK economy under the 2022-2023 energy price hike, where the loss of consumers' purchasing power and the vulnerability of mortgage costs to higher policy rates have been elements of paramount empirical relevance.
Creative Commons License: 
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Document Type: 
Working Paper

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