Impact of monetary policy on functional income distribution: A panel vector autoregressive analysis

This study examines the impact of monetary policy on functional income distribution, which is defined here as the level of real wages and the size of the labor share of income. This topic has often been overshadowed by analyses of personal income inequality. Although prior research has presented mixed evidence while focusing on short-term effects, we investigate the medium- to long-term distributional consequences of monetary tightening. Using a panel vector autoregressive framework and a dataset encompassing 15 advanced economies from 1970 to 2019, we analyze how real wages and the labor share respond to contractionary monetary policy. Our findings reveal that contractionary monetary policies lead to persistent declines in both real wages and the labor share. By disentangling the underlying transmission mechanisms, we identify the labor market channel as the primary driver: the scarring effects on wages and labor force participation endure even after output and prices stabilize. These results underscore the importance of incorporating long-term distributional considerations into the formulation of monetary policy. • Monetary policy’s effect on income distribution is studied using a panel VAR method • Evidence supports the presence of monetary policy’s persistent real effects • Contractionary monetary policy adversely impacts real wage levels and labor share • Labor market dynamics drive long-term inequality from contractionary policy shocks • Policymakers should consider this evidence when designing monetary policy