Research

WORKING PAPERS

When Do Persistent Supply Shocks Call for Hawkishness?

Central banks typically rely on the following heuristic: Look through transitory supply shocks to stabilize the output gap, but pivot to stabilizing inflation if shocks are persistent. Yet standard models provide little support for this heuristic. They justify it for markup shocks—a particular type of supply shock—but find that for the most common supply shocks— productivity, labor supply, energy prices—stabilizing the output gap is close to optimal even for persistent shocks. What, then, rationalizes a hawkish response to persistent supply shocks? The paper shows that, contrary to conventional wisdom, the risk of inflation expectations de-anchoring is insufficient: even with backward-looking expectations, output gap stabilization remains close to optimal. Instead, real wage rigidity provides a rationale. When real wages are sufficiently rigid, stabilizing the output gap becomes much more costly and optimal policy shifts toward inflation stabilization for persistent shocks, whether or not expectations can de-anchor. This suggests that monitoring real wage rigidity is at least as important as monitoring inflation expectations to assess the need for a hawkish pivot.

Fiscal Requirements for Price Stability when Households Are Not Ricardian

with Anna Rogantini Picco

Are restrictions on fiscal policy necessary for monetary policy to deliver price stability? When households are Ricardian, future fiscal surpluses must back the real value of public debt under stable prices. We show that when households are not Ricardian, fiscal requirements take a fundamentally different form: a limit on the debt-to-GDP ratio. Beyond that limit, the wealth effect of public debt on aggregate spending is so large that there is no natural rate of interest. To implement price stability when the debt-to-GDP limit holds, monetary policy must respond directly to the debt level, so that it tracks the natural rate.

Keeping Control over Boundedly Rational Expectations

with Magali Marx

R&R at the Journal of Money, Credit and Banking

How can central banks avoid losing control over inflation expectations? Under rational expectations, respecting the Taylor principle is needed to ward off self-fulfilling inflation. We reconsider the issue away from rational expectations, for a class of boundedly rational expectations embedding cognitive discounting and long-term learning. (1) Self-fulfilling inflation is no longer a concern, but too passive a monetary policy leads to inflation spirals. (2) Active monetary policies can be characterized without restricting to Taylor rules, as those that sufficiently increase a weighted average of present and future policy rates. (3) The more the central bank cares about output stabilization, the more it should deliver the necessary tightening through expectations of future hikes instead of current hikes.

Putting the I Back in the IS Curve

R&R at the Journal of the European Economic Association

How do interest rates affect aggregate consumption? The recent literature on household heterogeneity has revived the importance of the Keynesian cross, which amplifies the initial reaction of consumption to interest rate changes through high MPCs. Yet this channel still originates in households' intertemporal substitution. This paper shows how, once it is combined with investment, household heterogeneity creates a new channel that works entirely away from intertemporal substitution. High MPCs are not enough. The channel relies on an interaction between heterogeneity in MPCs and heterogeneity in the share of labor income in household incomes.

PUBLICATIONS