Household Heterogeneity and the Transmission of Foreign Shocks

This paper builds a Heterogeneous-Agent New-Keynesian Small Open Model Economy (HANKSOME) – combining the standard Bewley-Imrohoroğlu-Huggett-Aiyagari incomplete-markets household block with the Galí and Monacelli (2005) small-open-economy New Keynesian framework – to study how household heterogeneity shapes the transmission of a foreign credit-supply shock, motivated by Hungary’s foreign-currency mortgage boom of the 2000s and its sudden-stop reversal around 2009. Its central finding is that when households owe debt denominated in foreign currency, a floating exchange rate’s depreciation mechanically revalues that debt upward, reducing net worth and triggering a sharp contraction in consumption that is concentrated among highly leveraged, high-marginal-propensity-to-consume, low-wealth households – even though aggregate output actually rises on impact via a labor-supply response, so the usual “contractionary devaluation” mechanism is not what drives the welfare loss. As a result, a fixed exchange rate, despite generating its own recession through binding nominal rigidities, prevents most of this debt revaluation and is preferred by more than 90% of households in the paper’s Hungary-calibrated experiment, providing a welfare-based rationale for the empirically documented “fear of floating” that does not rely on devaluations being output-contractionary.

Monetary Cooperation during Global Inflation Surges

In a multicountry model with nominal wage rigidities, two sectors (tradable with convex supply, nontradable with flat supply), and free capital mobility, the paper studies optimal monetary policy during a global demand reallocation shock — a shift in preferences toward tradables (ω₀ > ω). Under cooperation (Proposition 1), the optimal response allows inflation to rise: higher tradable goods prices reduce real wages (restoring labor demand), generate expenditure switching back toward nontradables, and boost nontradable employment through an income effect. Cooperation achieves full employment as long as the inflation cost is below the full-employment threshold; otherwise it strikes the optimal inflation-unemployment balance. Under noncooperation (Proposition 3), each national central bank perceives it can attract capital inflows by raising its policy rate — inflows sustain nontradable demand and reduce the domestic sacrifice ratio of disinflation. But in a symmetric Nash equilibrium, synchronized rate hikes cancel each other through global credit market clearing; only the global monetary contraction remains. The result is lower inflation than under cooperation but higher unemployment — a competitive appreciation trap that mirrors the competitive depreciation failures of the Great Depression and the 2008 crisis, but in the opposite direction (global scarcity rather than deficiency of tradables). In a numerical example calibrated to α = 0.64 (convex tradable supply, implying 0.57 price-output elasticity, from Boehm and Pandalai-Nayar 2022) and ω = 0.3 (US pre-COVID tradables share), a 3 percentage point demand reallocation (matching the US COVID episode) requires approximately 1.5 percentage points of inflation to maintain full employment under cooperation; without any inflation, unemployment rises by approximately 8 percentage points. At ω₀ = 0.35, the uncooperative equilibrium reduces inflation by approximately 1 percentage point relative to cooperation but pushes unemployment to approximately 7 percent. For the COVID-19 episode, the authors conclude gains from cooperation were likely small (full employment maintained globally); for the 1980s synchronized tightening — when central banks explicitly sacrificed employment to fight inflation — the model implies substantially positive gains, consistent with the heated cooperation debates and the 1985 Plaza Accord.

Federica Romei | Macro Paper Warehouse

Household Heterogeneity and the Transmission of Foreign Shocks

Monetary Cooperation during Global Inflation Surges