Redistributive effects of monetary policy on labor income

October 26, 2021

In recent years, inequality has attracted a great deal of attention in monetary policy circles. A growing strand of the macroeconomic literature suggests that monetary policy is not immune to redistributive consequences, despite inequality not being an explicit target of its actions. The bulk of this debate centers around the relationship between monetary policy and asset prices, yet labor income represents a major source of inequality, and its relationship with monetary policy remains unexplored. The aim of this paper is to fill this gap.

To this end, the paper exploits administrative data from Portugal - an employer-employee dataset and the credit registry - and monetary policy since the Eurozone creation. The institutional setting helps identify a causal link from monetary policy to labor market outcomes, as Portugal is part of the Eurosystem and the European Central Bank sets monetary policy jointly for all member states.

The paper finds that softer monetary policy disproportionately increases worker-level wages and hours worked, and firm-level employment in small and young firms, which tend to be more financially constrained. Consistent with a back-loaded wage mechanism, monetary policy relaxes financial constraints and allows firms to increase the wage profile of their incumbent workers whose wages were previously back-loaded. The paper also provides evidence on the effects of monetary policy on capital-skill complementarities: following a monetary policy softening, small and young firms are able to increase both their physical and human capital by more. Importantly, the paper highlights the role played by both the firm balance-sheet and the bank lending channels for the transmission of the heterogeneous effects of monetary policy to labor market outcomes. These effects are substantially stronger during crisis times, i.e. when financial constraints are the most severe.

Click here to go to the paper by Martina Jasova, Caterina Mendicino, Ettore Panetti, José Luis Peydró, and Dominik Supera.


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