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A Note on Temporary Supply Shocks with Aggregate Demand Inertia

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  • Ricardo J. Caballero
  • Alp Simsek

Abstract

We study optimal monetary policy during temporary supply contractions when aggregate demand has inertia and the central bank is concerned about future constraints on expansionary policy. In this environment, it is optimal to run the economy hot until supply recovers. However, the policy does not remain loose throughout the low-supply phase. Overall, when the initial aggregate demand is low, the goal is to frontload the rate cuts to raise demand in anticipation of the recovery of supply. If inflation also has inertia, the central bank still overheats the economy during the low-supply phase but gradually cools it down over time.

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  • Ricardo J. Caballero & Alp Simsek, 2023. "A Note on Temporary Supply Shocks with Aggregate Demand Inertia," American Economic Review: Insights, American Economic Association, vol. 5(2), pages 241-258, June.
    • Handle: RePEc:aea:aerins:v:5:y:2023:i:2:p:241-58
    DOI: 10.1257/aeri.20220109
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    1. Ricardo J. Caballero & Alp Simsek, 2020. "Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect," NBER Working Papers 27712, National Bureau of Economic Research, Inc.
    2. Chan, Jenny & Diz, Sebastian & Kanngiesser, Derrick, 2022. "Energy Prices and Household Heterogeneity: Monetary Policy in a Gas-TANK," MPRA Paper 115975, University Library of Munich, Germany, revised Dec 2022.
    3. Nöller, Marvin & Balleer, Almut, 2023. "Monetary Policy in the Presence of Supply Constraints: Evidence from German Firm-level Data," VfS Annual Conference 2023 (Regensburg): Growth and the "sociale Frage" 277638, Verein für Socialpolitik / German Economic Association.
    4. Almut Balleer & Marvin Noeller, 2023. "Monetary Policy in the Presence of Supply Constraints: Evidence from German Firm-Level Data," CESifo Working Paper Series 10261, CESifo.
    5. Balleer, Almut & Noeller, Marvin, 2023. "Monetary policy in the presence of supply constraints: Evidence from German firm-level data," Ruhr Economic Papers 1060, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    6. Krane, Spencer David & Melosi, Leonardo & Rottner, Matthias, 2023. "Learning monetary policy strategies at the effective lower bound with sudden surprises," Discussion Papers 22/2023, Deutsche Bundesbank.
    7. Spencer D. Krane & Leonardo Melosi & Matthias Rottner, 2023. "Learning Monetary Policy Strategies at the Effective Lower Bound with Sudden Surprises," Working Paper Series WP 2023-22, Federal Reserve Bank of Chicago.

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    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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