Redistributive Policy Shocks and Monetary Policy with Heterogeneous Agents

Abstract Governments in EMDEs routinely intervene in agricultural markets to stabilize food prices in response to adverse shocks. Such interventions involve a large increase in the procurement and redistribution of agricultural output, which we refer to as a redistributive policy shock. What is the impact of a redistributive policy shock on inflation and the distribution of consumption among rich and poor households? We build a two‐sector‐two‐agent NK‐DSGE model and estimate it for India using Bayesian methods. We characterize optimal monetary policy and show that the welfare costs of redistributive policy shocks are significantly higher under nonoptimized rules.