Effects of monetary policy on the skill premium and the growth rate in a directed technical change model with heterogeneous cash-in-advance constraints

This article analyses the balanced-growth-path effects of monetary policy (inflation) on the skill premium and the growth rate in the context of a directed technical change model with cash-in-advance (CIA) constraints specific to the unskilled and skilled sectors. Calibrating the model using data from 36 countries, the presence of more stringent CIA constraints in the unskilled sector, as supported by the literature, causes inflation to have a positive effect on the skill premium. Moreover, it also increases the negative impact of inflation on the growth rate in relation to the baseline scenario of homogeneous CIA constraints. A lower labour share and higher inflation in general magnify these effects on both variables while a relative lower importance of the unskilled sector does the opposite with respect to the skill premium. Therefore this article innovates in three important ways: (i) we add an additional channel through which inflation affects inequality; (ii) we highlight the importance of avoiding ignoring differences of liquidity constraints across the economy in the context of endogenous growth models to not underestimate the negative long-run impacts of inflation; (iii) the results suggest that developing countries that have difficulty in achieving price stability in the long-run can mitigate the negative effects of inflation by reducing constraints faced by the unskilled sector and promoting the development of the skilled sector.