European Central Bank working paper finds keeping rates unchanged until mid 2022 offset inflation driven redistribution in the euro area

The European Central Bank published a working paper assessing how the euro area’s 2021–2022 inflation surge and the subsequent monetary policy response affected households across age and wealth. Using an estimated two-asset Heterogeneous Agent New Keynesian model with an overlapping generations structure, it finds that inflationary shocks would have redistributed welfare from younger and poorer households to older and wealthier ones, but keeping policy rates unchanged until mid-2022, when inflation had already exceeded 8%, largely offset those distributional effects. The model attributes 2021–2022 inflation mainly to price markup and monetary shocks. Inflation disproportionately hurts younger and poorer workers by eroding real labour income and limiting their ability to smooth consumption, while older and richer households are relatively insulated by holdings that are predominantly real rather than nominal. Expansionary monetary policy has the opposite distributional profile by supporting labour demand and depressing asset returns, and a response based solely on a standard Taylor rule would not have mitigated the redistribution; in a counterfactual without the expansionary monetary shocks of 2021–2022, peak inflation would have been 1.9 percentage points lower and average GDP growth in 2021–2023 about 0.9 percentage points weaker. The paper also reports that the redistributive effects of systematic interest rate responses to inflation are nonlinear and shock-specific, leaving redistribution from the 2021–2022 shocks broadly unchanged under different Taylor rule coefficients. It further highlights that conclusions can differ by metric, with analysis based on current consumption not supporting the same inference as model-consistent welfare about monetary policy preventing redistribution.