Monetary transmission with income risk

In periods of distress, observed and perceived income risk tends to rise. Does this heightened income risk affect monetary transmission? This paper first shows that in partial equilibrium, heightened income risk dampens the substitution effect of interest rate changes but amplifies the indirect inco...

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Bibliographic Details
Published in:The Scandinavian journal of economics 2023-04, Vol.125 (2), p.441-460
Main Author: Holm, Martin B.
Format: Article
Language:English
Subjects:
Equilibrium
Income risk
Interest rates
monetary policy
Psychological distress
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Summary:In periods of distress, observed and perceived income risk tends to rise. Does this heightened income risk affect monetary transmission? This paper first shows that in partial equilibrium, heightened income risk dampens the substitution effect of interest rate changes but amplifies the indirect income effect of wage changes. The effects are sizable in partial equilibrium. An increase in income risk consistent with heightened risk during recessions affects interest rate and wage responses by around one‐third. However, because income risk dampens the effects of interest rate changes but amplifies the effects of wage changes, its effect is weaker in general equilibrium, dampening monetary transmissions to consumption by around 11 percent.
ISSN:0347-0520
1467-9442
DOI:10.1111/sjoe.12516