CeBER Working Paper No. 2020-9

We devise a North-South endogenous growth model with international trade and money to study the effects of inflation (and monetary policy) on wage inequality, specialization, and growth. The relationship between monetary policy and wage inequality depends on the fact that skilled-production firms are less credit constrained than unskilled-production firms. Interestingly, inflation affects the structure of production by increasing the production share made by skilled-intensive firms, and decreases economic growth. Furthermore, inflation decreases the difference of wage inequality between countries; shrinking the skill premia difference. Moreover, inflation and trade have opposite effects on wage inequality and on specialization: while trade tends to decrease intra-South wage inequality, inflation tends to increase it; while trade tends to increase the number of different intermediate goods produced with unskilled technology in the South; inflation acts the other way around. Results are confirmed quantitatively.