The Supply-Side Effects of Monetary Policy

Abstract

We propose a supply-side channel for the transmission of monetary policy. We show that in an economy with heterogeneous firms and endogenous markups, demand shocks have first-order effects on aggregate productivity. If high-markup firms have lower pass-throughs than lowmarkup firms, as is consistent with the empirical evidence, then a monetary easing reallocates resources to high-markup firms and alleviates misallocation. In this case, positive "demand shocks" are accompanied by endogenous positive "supply shocks" that raise output and productivity, lower inflation, and flatten the Phillips curve. We derive a tractable four-equation dynamic model and use it to show that monetary shocks generate a procyclical hump-shaped response in TFP and endogenous cost-push shocks in the New Keynesian Phillips curve. A calibration of the model suggests that the supply-side effect increases the half-life of a monetary shock's effect on output by about 30% and amplifies the cumulative effect on output by about 70%. We provide empirical evidence of the micro-level reallocations that generate procyclical TFP using identified monetary shocks.

Tracing Banks’ Credit Allocation to their Funding Costs

“…Therefore, even in the best case in which banks are perfectly able to insulate their profits from fluctuations in funding costs by rebalancing their loan portfolios, this asset-side response can in and of itself affect the aggregate economy if the reallocation of capital, holding constant its total volume, matters for aggregate output (e.g., Baqaee, Farhi, and Sangani, 2021).…”

Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy

“…Our algorithm is simple to code using Dynare and can be easily generalized to other problems. Zanetti and Hamano (2020), Andrés et al, 2021, Nakov and Webber, 2021or Baqaee et al, 2021, in cyclicality (David and Zeke, 2021) or in firm-level productivity trends (Adam and Weber, 2019).…”

Monetary Policy Under Labor Market Power

“…Market power and its effects on macroeconomic dynamics is a subject of growing interest. The literature focuses almost exclusively on product market power, such as De Loecker et al (2020), Wang and Werning (2020), Baqaee et al (2021) and the books by Philippon (2019) and Eeckhout (2021). It has been shown that the recent rise in product market power can be responsible for several recent macroeconomic trends, most notably, for the flattening of the price Phillips curve, and can matter for the transmission of monetary policy (Duval et al, 2021;Ferrando et al, 2021;Kroen et al, 2021).…”