Description

We study the role of household heterogeneity in skills over the business cycle in the U.S. We document that the ratio of labor income of skilled to unskilled workers (the earnings gap) is coun-tercyclical and increases in response to contractionary monetary policy. This result is due to the higher rigidity in unskilled workers’ wages and gross substitution between skills in production. We find that in a calibrated New Keynesian model, when the earnings gap is countercyclical and un-skilled workers are more financially constrained, the impact of monetary policy shocks can be twice as strong as with homogeneous wage rigidities.