In many parts of the world, the economic fortunes of poorer and richer regions have drifted apart over recent years. A natural question is whether these trends have been reinforced or mitigated by economic policies at the macro level. Among the different policy domains, monetary policy emerges as a particularly interesting candidate given its dominant role in steering macroeconomic outcomes over the past decade. 

A new study by Sebastian Hauptmeier, Fédéric Holm-Hadulla and Katerina Nikalexi finds that monetary policy tightening aggravates regional inequality and monetary policy easing mitigates it. 

The analysis builds on granular data at the city- and county-level in the euro area. In line with the evidence at the macroeconomic level, it documents a sizeable response of regional output and employment to monetary policy shocks. But this response is much stronger and persistent in poorer than in richer regions. 

For instance, the output contraction in response to a monetary policy tightening is more than a third higher in the poorest than in the richest 5% of the regions. Moreover, this gap widens over time: while output in the richer regions fully recovers after a few years, the contraction persists in the poorer ones. As a consequence, monetary policy shocks exert a lasting impact on the relative economic fortunes of these different types of regions. 

Besides offering an important new angle on the increasingly active debate on the causes and consequences of regional inequality, these findings add to recent ‘grumblings about the extent to which [the natural rate] hypothesis fully characterizes the world’ (Blanchard, 2018: Should We Reject the Natural Rate Hypothesis?, Journal of Economic Perspectives 32(1): 97-120). 

As one of its key implications, the natural rate hypothesis posits that monetary policy effects merely smooth out shorter-term cyclical fluctuations in economic activity. The persistent output and employment responses in poor regions, as documented in this study, instead imply that monetary policy may also affect the longer-term evolution of these variables, thus amplifying its relevance for economic welfare. 



More details available here:
Monetary policy and regional inequality 

Contact and Disclaimer: 

Fédéric Holm-Hadulla
Directorate General Monetary Policy European Central Bank 

The views expressed here are those of the authors and do not necessarily reflect those of the European Central Bank.