On the Response of Inflation and Monetary Policy to an Immigration Shock

Benjamín García and Juan Guerra-Salas

Central Bank of Chile Working Paper 872. April 2020.

R&R Journal of Human Capital.

Abstract: An immigration shock has an ambiguous effect on inflation. On one hand, aggregate consumption increases with a suddenly larger population; this “demand channel” creates inflationary pressures. On the other hand, the labor market becomes more slack as immigrants search for jobs, containing wage growth; this “labor supply channel” creates disinflationary pressures. The response of an inflation-targeting central bank to an immigration shock is, therefore, not obvious. We study these competing channels in a New Keynesian model of a small open economy with search frictions in the labor market. Our simulations are designed to characterize the possible response of inflation and monetary policy in Chile, a small open emerging country that has experienced a substantial immigration flow in recent years.

Keywords: Immigration; Inflation; Monetary Policy; DSGE models; Small open economies.

JEL classification codes: E24; E52; F22; F41; J61.

Non-technical summary in Investigación al Día, the Central Bank of Chile’s quarterly research bulletin (in Spanish).