I develop an analytical framework for monetary policy in a multi-sector economy with a general input-output network. I derive the Phillips curve and welfare as a function of the underlying production primitives. Building on these results, I characterize (i) the correct definition of aggregate inflation and (ii) how the optimal policy trades off inflation in different sectors, based on the production structure. I construct two novel inflation indicators. The first yields a well-specified Phillips curve. Consistent with the theory, this index provides a better fit in Phillips curve regressions than conventional specifications with consumer prices. The second is an optimal policy target, which captures the tradeoff between stabilizing aggregate output and relative output across sectors. Calibrating the model to the U.S. economy I find that targeting consumer inflation generates a welfare loss of 0.8% of per-period GDP relative to the optimal policy, while targeting the output gap is close to optimal.
This note presents an overview of my research on the monetary/fiscal policy mix. I discuss why central bank’s ability to control inflation requires fiscal backing. The post-Volcker consensus about the importance of central bank independence was a response to the fiscal nature of the Great Inflation of the 1970s. This consensus is now called into question in light of the limits of monetary policy and the little appetite for fiscal orthodoxy following two severe re- cessions. In this context, a coordinated strategy between the monetary and fiscal authorities works as an automatic stabilizer, reducing the likelihood of a disastrous conflict between the two authorities. Under this coordinated strategy, the fiscal authority introduces an emergency budget, while the monetary authority announces a temporary increase in the inflation target to accommodate the emergency budget. The strategy results in only moderate levels of inflation by separating long-run fiscal sustainability from a short-run policy intervention. In the context of the Euro area, Eurobonds could be used to achieve better coordination between monetary and fiscal policy.
We study optimal monetary policy and central bank communication when firms make nominal pricing decisions under uncertainty and when the monetary authority likewise has incomplete information about the current economic state. We find that the optimal monetary policy implements flexible-price allocations despite this multitude of measurability constraints; we explore a series of different implementations. Away from such policies, we find that public communication by the central bank is welfare-improving as long as either firm information or central bank information is sufficiently precise.
Introducing heterogeneous households to a New-Keynesian small open economy model amplifies the real income channel of exchange rates: the rise in import prices from a depreciation lowers households’ real incomes, and leads them to cut back on spending. This channel counteracts the standard expenditure-switching channel of exchange rates, and can result in a contractionary effect of a depreciation on domestic output. We study the monetary policy implications of a large and dominant real income channel.
We study the monetary-fiscal mix in the European Monetary Union. The medium and long-run effects of conventional and unconventional monetary policy can be analysed by combining monetary policy shocks identified in a Structural VAR, and the general government budget constraint featuring a single central bank and multiple fiscal authorities. In response to a conventional easing of the policy rate, the real discount rate declines, absorbing the increase in deficit due to the fiscal policy leaning towards the easing. Conversely, in response to an unconventional easing of the long end of the yield curve, the discount rate declines strongly, while the primary fiscal surplus barely moves. The long-run effect of unconventional monetary easing on inflation is about half than that of conventional, a result which also explains the muted response of fiscal policy. Results do not point to large differences across countries.