Implications of Food Subsistence for Monetary Policy and Inflation

We introduce subsistence requirements in food consumption into a simple new-Keynesianmodel with flexible food and sticky non-food prices. We study how the endogenous structuraltransformation that results from subsistence affects the dynamics of the economy, the design ofmonetary policy, and the properties of inflation at different levels of development. A calibratedversion of the model encompasses both rich and poor countries and broadly replicates theproperties of inflation across the development spectrum, including the dominant role played bychanges in the relative price of food in poor countries. We derive a welfare-based loss functionfor the monetary authority and show that optimal policy calls for complete (in some cases nearcomplete)stabilization of sticky-price non-food inflation, despite the presence of a foodsubsistencethreshold. Subsistence amplifies the welfare losses of policy mistakes, however,raising the stakes for monetary policy at earlier stages of development