The Long-Run Effects of Monetary Policy

Abstract

Is the effect of monetary policy on the productive capacity of the economy long lived? Yes, in fact we find such impacts are significant and last for over a decade based on: (1) merged data from two new international historical databases; (2) identification of exogenous monetary policy using the macroeconomic trilemma; and (3) improved econometric methods. Notably, the capital stock and total factor productivity (TFP) exhibit hysteresis, but labor does not. Money is non-neutral for a much longer period of time than is customarily assumed. A New Keynesian model with endogenous TFP growth can reconcile all these empirical observations.

Hysteresis and full employment in a small open economy

“…Under the model with hysteresis and credit constraints it is possible for employment to return to its pre-recession trend within typical business cycle frequencies, while output need not. This feature of the model appears to match the general experience of many advanced economies well (see Jordà et al, 2020)), including Australia following the 1990-91 recession and the GFC. This section seeks to evaluate the efficacy of fiscal stimulus through the calculation of output, employment and welfare multipliers.…”

“…6 Would a change in monetary policy framework have improved outcomes? Garga and Singh (2019) and Jordà et al (2020) consider alternative monetary policy rules in the presence of output hysteresis. Garga and Singh (2019) find output hysteresis arises away from the ZLB where monetary policy is conducted based on the Taylor rule, but not under strict inflation-targeting.…”

“…As a consequence, we do not consider strict inflation-targeting as an alternate monetary policy rule as they do. Jordà et al (2020) have recommended that central banks should augment standard…”

“…On the other hand, Hall and Kudlyak (2020) and Jordà et al (2020) have observed the tendency of employment and unemployment to recover following recessions, whereas output and productivity commonly do not recover to levels that would be predicted based on their pre-recession trends.…”

“…Further, Ball (2014), Bianchi et al (2019), Blanchard et al (2015), Cerra and Saxena (2005), Cerra et al (2013), Cerra and Saxena (2017), Cerra et al (2020), Fatás and Summers (2018), Gechert et al (2019), and Jordà et al (2020) have found broad empirical support for the hysteresis hypothesis, whereby demand driven recessions can have highly persistent, or even permanent effects, on the level of output and total factor productivity.…”