Inflation, monetary policy and the hierarchy of consumer goods

In this chapter, I argue that the composition of demand, in particular the existence of a hierarchy of needs, should be taken into account when assessing the effectiveness of monetary policy, which aims to control inflation through aggregate demand. Inflation is rarely evenly spread across all categories of consumption items: instead, the price of certain goods tends to rise faster than others. It should not be expected that monetary policy has the same impact regardless of which category of goods drives the inflation process. To substantiate this claim, I use a simple model distinguishing between two types of consumption goods: basic goods and comfort goods. Households spend on comfort goods (and save) only once they have satiated their need for basic goods. I then introduce several shocks in the model, consisting of located price increases and reduction in disposable income – taken as a proxy for restrictive monetary policy as it reduces aggregate demand. The results indicate the existence of an asymmetry between the case when inflation is driven by an increase in the price of comfort goods, as opposed to when it comes from basic goods.