IMF Working Papers

External Shocks and Monetary Policy Trade-offs in Low-Income Countries

By Juan Passadore, Giovanni Sciacovelli, Filiz D Unsal, Carlos van Hombeeck

October 3, 2025

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Juan Passadore, Giovanni Sciacovelli, Filiz D Unsal, and Carlos van Hombeeck. "External Shocks and Monetary Policy Trade-offs in Low-Income Countries", IMF Working Papers 2025, 204 (2025), accessed October 4, 2025, https://doi.org/10.5089/9798229025836.001

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We present an Open Economy HANK model with relevant features for Low-Income Countries (LICs): hand-to-mouth households and a subsistence consumption for tradable goods. With the model calibrated for a representative LIC, we illustrate our broader framework with a shock to external prices. The shock causes a consumption-led recession, an increase in inflation and a drop in real wages. Consumption inequality rises: poor households cannot insure against the shock, unlike richer households who can tap into their wealth. Monetary policy is unable to substantively improve poorer households’ welfare, due to offsetting effects on real wages and labor demand. Simulations of the effects of alternative monetary policy responses on inequality yield similar findings. In this setting, fiscal transfers are a more effective tool for redistribution across households.

Subject: Consumption, Income, Inflation, Labor, National accounts, Prices, Real wages

Keywords: Consumption, Income, Inequality, Inflation, Low-income Countries, Monetary Policy, Open Economy HANK, Real wages

Publication Details

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