TANK meets Diaz-Alejandro: Household heterogeneity, non-homothetic preferences & policy design

TL;DR

This paper examines how household heterogeneity in financial access and consumption preferences influences the transmission of foreign shocks, policy effectiveness, and exchange rate regimes in a small open economy.

Contribution

It introduces a Two-Agent New Keynesian model incorporating limited financial access and non-homothetic preferences, highlighting their impact on macroeconomic dynamics and policy design.

Findings

Households with limited financial access spend more on commodities.

Model shows heterogeneity amplifies foreign shocks and affects policy outcomes.

Opposing household preferences influence optimal monetary and fiscal policies.

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.