Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/324348 
Year of Publication: 
2025
Series/Report no.: 
IZA Discussion Papers No. 17950
Publisher: 
Institute of Labor Economics (IZA), Bonn
Abstract: 
We investigate how the composition of expenditure shapes the transmission of monetary policy in a currency union. European Monetary Union data reveal three facts: (1) higher inequality countries have larger service expenditure shares; (2) monetary policy has a weaker output impact in these high-service-share, high-inequality countries; and (3) monetary policy induces systematic trade flows between high- and low-service-share countries. We develop a New Keynesian model with non-homothetic preferences and heterogeneous sectoral income that rationalizes these facts. Pro-cyclical inequality, driven by wealthier households' greater income exposure to services, buffers poorer households' consumption to contractionary shocks, dampening overall policy transmission. Our findings suggest that accounting for cross-country differences in consumption and income distributions is essential for understanding common monetary policy.
Subjects: 
currency union
monetary policy
inequality
Document Type: 
Working Paper

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