Energy Prices and Household Heterogeneity: Monetary Policy in a Gas-TANK

How does household heterogeneity affect the transmission of an energy price shock? What are the implications for monetary policy? We develop a small open economy TANK model that features labor and an energy import good as production inputs (Gas-TANK). Given complementarities in production inputs, higher energy prices reduce the labor share of total income. Due to borrowing constraints, this translates into a drop in aggregate demand. Higher price flexibility insures firm profits from adverse energy price shocks, further depressing labor income and demand. We illustrate how the transmission of shocks in a RANK versus a TANK depends on the degree of complementarity between energy and labor in production and the degree of price rigidities. Optimal monetary policy is less contractionary in a TANK and can even be expansionary when credit constraints are severe. Finally, the contractionary effect of an energy price shock on demand cannot be generalized to alternate supply shocks, as the specific nature of the supply shock affects how resources are redistributed in the economy.