Tobias Broer, Niels-Jakob Hansen, Erik Öberg and Per Krusell.

Assistant Professor Tobias Broer and Professor Per Krusell have had their paper "The New Keynesian transmission mechanism: a heterogeneous agent perspective", (with Niels-Jakob Hansen (IMF) and Erik Öberg (Uppsala University)) accepted for publication in the Review of Economic Studies, one of the world’s top five journals in economics.

We sat down with Tobias Broer to ask a few questions.

Can you describe what your paper is about?

We study how changes in a central bank’s policy interest rate affect the economy, both in terms of aggregate activity and inequality. For this purpose, we augment the standard framework for monetary analysis - the New Keynesian model - to encompass inequality in labor and dividend income. Versions of this model is used by academics, central banks and other government agencies across the world to understand and forecast the effects of monetary policy, but until very recently, such models have relied on the assumption of a representative agent and thus not been able to address the relationship between monetary policy and inequality.

In our heterogeneous-agent version of this model, we show that unless wages are sufficiently rigid, the transmission of monetary policy to aggregate output collapses: no matter how much the interest rate is lowered, aggregate output will not increase. This highlights that the transmission mechanism of New Keynesian models without rigid wage setting is implausible.

When wages are sufficiently rigid, we show that an intuitive and empirically plausible transmission mechanism is restored. These theoretical findings suggest that 1) inequality cannot be ignored in the study of monetary policy, and 2) that measuring the degree of labor market rigidity is utterly important to evaluate the strength of the monetary transmission mechanism.

How do you think your paper will influence future research in the area?

We think that this paper should encourage us to think more deeply about the role of frictions in labor markets for monetary policy. And we are doing follow-up work in this dimension.

Where does the idea for this paper originate from?

The paper originated during a PhD course called “Applied Macroeconomic Research” here at Stockholm University. Erik Öberg and Niels-Jakob Hansen, like the other students in the course, sat down with us during one term to work intensively on their research ideas. After some more work, the final outcome is this paper.