Monetary policy mitigated inflationary redistribution from young to old
A new ECB working paper finds that monetary policy largely offset the substantial redistribution from young and poor to older and wealthier households caused by the 2021-2022 euro area inflationary surge. This was achieved by keeping interest rates unchanged until mid-2022.
Inflation's uneven burden
The 2021-2022 inflationary surge in the euro area would have generated significant redistribution from younger and poorer households to older and wealthier ones, according to a new ECB working paper.
Researchers Michał Brzoza-Brzezina and Rodolfo Dinis Rigato used an estimated two-asset Heterogeneous Agent New Keynesian (HANK) model with an overlapping generations (OLG) structure to analyze the macroeconomic shocks driving inflation.
They found that these shocks disproportionately hurt poorer and younger households by eroding the real value of labor income, while older and wealthier households, holding real assets, were better protected.
However, by keeping interest rates unchanged until mid-2022, monetary policy largely offset these distributional effects, preventing a strong shift of wealth.
The mechanics of policy offset
The HANK-OLG model, calibrated to match euro area demographic and asset accumulation profiles, features rich household heterogeneity, including different cohorts, liquid and illiquid assets, and income/wealth inequality.
The model was estimated using euro area macroeconomic time series from 2000-2023.
The study found that expansionary monetary policy, by boosting labor demand and reducing returns on assets held by older and richer households, generated redistributive effects that mirrored and counteracted those of the inflationary shocks.
This mechanism helped to even out the overall redistribution picture, which would have been much more skewed without the loose monetary policy stance.
Beyond standard rules
This research highlights the critical, often overlooked, distributional role of monetary policy.
While standard Taylor rules might focus solely on inflation, this paper demonstrates that central banks can significantly mitigate wealth shifts between generations and income groups.
The findings suggest that policymakers should consider a broader set of indicators beyond inflation when assessing the optimal monetary policy response.