Regional heterogeneity and monetary policy

We study the implications of regional heterogeneity within a currency union for monetary policy. We ask, first, does monetary policy mitigate or exacerbate ex-post regional dispersion over the business cycle? And second, does ex-ante regional heterogeneity increase or dampen the aggregate effects of a given monetary policy? To help answer these questions, we use detailed U.S. micro data to explore the extent to which mortgage activity differed across local areas in response to the first round of Quantitative Easing (QE1), announced in November 2008. We document that QE1 increased both mortgage activity and real spending but that its effects were smaller in parts of the country with the largest employment declines. This heterogeneous regional effect is driven by the fact that collateral values were most depressed in the regions with the largest employment declines, reducing the extent to which borrowers were able to benefit from rate decreases. We explore the implications of our empirical results for theoretical monetary policymaking using an incomplete-markets, heterogeneous-agent model of a monetary union whereby monetary policy influences local spending through collateralized lending. Preliminary results suggest that both the distributional and aggregate consequences of monetary policy depend on the joint distribution of local shocks. We find that if regions with low relative income also have depressed collateral values (as in 2008), then expansionary monetary policy will further exacerbate regional dispersion of economic activity and will also be less effective at stimulating aggregate spending.