IMF Paper on Cyclical Inequality and Monetary Policy: Balancing Stabilization and Redistribution
SDG 10: Reduced Inequalities | SDG 8: Decent Work and Economic Growth | SDG 17: Partnerships for the Goals
Ministry of Finance | Reserve Bank of India (RBI)
The IMF Working Paper titled ‘Cyclical Inequality in the Cost of Living and Implications for Monetary Policy’ identifies a critical “MPC-price stickiness” relationship, documenting that households with higher Marginal Propensities to Consume (MPCs)—typically renters and mortgagors—disproportionately consume goods with more flexible prices. Consequently, these households face more cyclical and volatile inflation, experiencing up to 40% higher inflation following expansionary monetary shocks compared to low-MPC homeowners. This “inflation heterogeneity” creates a novel trade-off for central banks between aggregate stabilization and social redistribution.
Key strategic findings and model implications include:
The Redistribution Channel: Traditional Heterogeneous Agent New Keynesian (HANK) models highlight a Redistribution Channel where monetary policy effectiveness hinges on the relationship between MPCs and the cyclicality of real income
Efficacy Gap: Ignoring heterogeneous consumption baskets leads to a 15% overstatement of monetary policy effectiveness.
General Equilibrium Dampening: Because high-MPC households face more flexible prices, expansionary shocks erode their real income faster, weakening the “Keynesian multiplier” and overall demand.
Triple Divine Coincidence: The paper argues that traditional “divine coincidence”—where stabilizing output gaps also stabilizes prices—only holds if households consume identical baskets.
Optimal Policy Shift: In economies with high cyclical inequality, it may be optimal to stabilize the headline CPI rather than the core CPI to protect the cost of living for vulnerable, high-MPC groups.
What is the “Redistribution Channel” in Heterogeneous Agent New Keynesian (HANK) models? The redistribution channel refers to how monetary policy affects aggregate demand by shifting real income between households with different spending behaviors. If a policy shock increases the real income of “hand-to-mouth” consumers (who have high MPCs) more than that of “savers,” the resulting boost to aggregate consumption is amplified. However, the 2025 study highlights that if these high-MPC households face more flexible prices, the resulting higher inflation in their specific consumption baskets can “dampen” this channel by eroding their real purchasing power.
What is "Price Stickiness"? It refers to how slowly or quickly the price of a good adjusts to changes in the economy. "Sticky" prices (like a gym membership or an iPhone) stay constant for long periods due to contracts or high menu costs. "Flexible" prices (like gasoline or tomatoes) can change daily, making the households that rely on them highly sensitive to immediate market shifts.
Policy Relevance
The study is highly relevant for India, where a significant portion of the population operates in the informal sector with high MPCs and faces volatile prices for essential flexible-price goods like food and fuel.
Inflation Impact on Vulnerable Groups: The RBI’s Monetary Policy Committee must account for how “inflation shocks” disproportionately impact the real income of these vulnerable groups, potentially leading to lower-than-expected consumption growth despite low repo rates.
Fiscal-Monetary Coordination: The findings suggest that the Ministry of Finance should complement monetary actions with targeted fiscal transfers to high-MPC households to prevent cyclical inequality from undermining national growth strategies.
Refining Target Metrics: There is a strategic case for evaluating if India’s inflation-targeting framework should assign greater weight to the stability of flexible-price sectors that dominate the consumption baskets of the poor to mitigate uninsurable idiosyncratic risks.
Follow the full paper here: Cyclical Inequality in the Cost of Living and Implications for Monetary Policy