Redistributive Policy Shocks and Monetary Policy with Heterogeneous Agents

Abstract

Governments in EMDEs routinely intervene in agriculture markets to stabilize food prices in the wake of adverse shocks. Such interventions involve a large increase in the procurement and redistribution of agriculture output, which we refer to as a redistributive policy shock. What is the impact of a redistributive policy shock on inflation and the distribution of consumption amongst rich and poor households? We build a two-sector-two-agent NK-DSGE model (2S-TANK) to address these questions. Using Indian data, we estimate the model using a Bayesian approach. We characterize optimal monetary policy. We show that the welfare costs of redistributive policy shocks are substantially higher when non-optimized rules are used to set monetary policy in response to such shocks.