TANK meets Diaz-Alejandro: Household heterogeneity, non-homothetic preferences & policy design (2201.02916v1)

Abstract: This paper studies the role of households' heterogeneity in access to financial markets and the consumption of commodity goods in the transmission of foreign shocks. First, I use survey data from Uruguay to show that low income households have poor to no access to savings technology while spending a significant share of their income on commodity-based goods. Second, I construct a Two-Agent New Keynesian (TANK) small open economy model with two main features: (i) limited access to financial markets, and (ii) non-homothetic preferences over commodity goods. I show how these features shape aggregate dynamics and amplify foreign shocks. Additionally, I argue that these features introduce a redistribution channel for monetary policy and a rationale for "fear-of-floating" exchange rate regimes. Lastly, I study the design of optimal policy regimes and find that households have opposing preferences a over monetary and fiscal rules.