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Post-COVID Inflation & the Monetary Policy Dilemma: An Agent-Based Scenario Analysis

Author

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  • Max Sina Knicker
  • Karl Naumann-Woleske
  • Jean-Philippe Bouchaud
  • Francesco Zamponi

Abstract

The economic shocks that followed the COVID-19 pandemic have brought to light the difficulty, both for academics and policy makers, of describing and predicting the dynamics of inflation. This paper offers an alternative modelling approach. We study the 2020-2023 period within the well-studied Mark-0 Agent-Based Model, in which economic agents act and react according to plausible behavioural rules. We include a mechanism through which trust of economic agents in the Central Bank can de-anchor. We investigate the influence of regulatory policies on inflationary dynamics resulting from three exogenous shocks, calibrated on those that followed the COVID-19 pandemic: a production/consumption shock due to COVID-related lockdowns, a supply-chain shock, and an energy price shock exacerbated by the Russian invasion of Ukraine. By exploring the impact of these shocks under different assumptions about monetary policy efficacy and transmission channels, we review various explanations for the resurgence of inflation in the United States, including demand-pull, cost-push, and profit-driven factors. Our main results are four-fold: (i) without appropriate fiscal policy, the shocked economy can take years to recover, or even tip over into a deep recession; {(ii) the success of monetary policy in curbing inflation is primarily due to expectation anchoring, rather than to the direct economic impact of interest rate hikes; (iii) however, strong inflation anchoring is detrimental to consumption and unemployment, leading to a narrow window of ``optimal'' policy responses due to the trade-off between inflation and unemployment;} (iv) the two most sensitive model parameters are those describing wage and price indexation. The results of our study have implications for Central Bank decision-making, and offers an easy-to-use tool that may help anticipate the consequences of different monetary and fiscal policies.

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  • Max Sina Knicker & Karl Naumann-Woleske & Jean-Philippe Bouchaud & Francesco Zamponi, 2023. "Post-COVID Inflation & the Monetary Policy Dilemma: An Agent-Based Scenario Analysis," Papers 2306.01284, arXiv.org, revised Jan 2024.
    • Handle: RePEc:arx:papers:2306.01284
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    References listed on IDEAS

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    1. Dimitris Christelis & Dimitris Georgarakos & Tullio Jappelli & Maarten van Rooij, 2020. "Trust in the Central Bank and Inflation Expectations," International Journal of Central Banking, International Journal of Central Banking, vol. 16(6), pages 1-37, December.
    2. Alan S. Blinder, 1982. "The Anatomy of Double-Digit Inflation in the 1970s," NBER Chapters, in: Inflation: Causes and Effects, pages 261-282, National Bureau of Economic Research, Inc.
    3. Ricardo Reis, 2022. "The burst of high inflation in 2021–22: how and why did we get here?," BIS Working Papers 1060, Bank for International Settlements.
    4. Isabella M. Weber, 2022. "Big Oil’s Profits and Inflation: Winners and Losers," Challenge, Taylor & Francis Journals, vol. 65(5-6), pages 151-159, November.
    5. Jean-Philippe Bouchaud & Stanislao Gualdi & Marco Tarzia & Francesco Zamponi, 2017. "Optimal Inflation Target: Insights from an Agent-Based Model," Papers 1709.05117, arXiv.org, revised Feb 2018.
    6. Francois de Soyres & Ana Maria Santacreu & Henry L. Young, 2022. "Fiscal policy and excess inflation during Covid-19: a cross-country view," FEDS Notes 2022-07-15-1, Board of Governors of the Federal Reserve System (U.S.).
    7. Alan S. Blinder & Jeremy B. Rudd, 2013. "The Supply-Shock Explanation of the Great Stagflation Revisited," NBER Chapters, in: The Great Inflation: The Rebirth of Modern Central Banking, pages 119-175, National Bureau of Economic Research, Inc.
    8. Stanislao Gualdi & Marco Tarzia & Francesco Zamponi & Jean-Philippe Bouchaud, 2017. "Monetary policy and dark corners in a stylized agent-based model," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 12(3), pages 507-537, October.
    9. Mr. Jorge A Alvarez & Mr. John C Bluedorn & Mr. Niels-Jakob H Hansen & Youyou Huang & Evgenia Pugacheva & Alexandre Sollaci, 2022. "Wage-Price Spirals: What is the Historical Evidence?," IMF Working Papers 2022/221, International Monetary Fund.
    10. Giovanni Dosi & Andrea Roventini, 2019. "More is different ... and complex! the case for agent-based macroeconomics," Journal of Evolutionary Economics, Springer, vol. 29(1), pages 1-37, March.
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    12. repec:hal:spmain:info:hdl:2441/1a9acst1l284eo8kvqrqrnlbl1 is not listed on IDEAS
    13. Bouchaud, Jean-Philippe & Gualdi, Stanislao & Tarzia, Marco & Zamponi, Francesco, 2018. "Optimal inflation target: Insights from an agent-based model," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 12, pages 1-27.
    14. Stanislao Gualdi & Marco Tarzia & Francesco Zamponi & Jean-Philippe Bouchaud, 2017. "Monetary policy and dark corners in a stylized agent-based model," Post-Print hal-03985776, HAL.
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    Cited by:

    1. Leonardo Ciambezi & Mattia Guerini & Mauro Napoletano & Andrea Roventini, 2023. "Rethinking Inflation in an Agent-Based Macroeconomic Model," GREDEG Working Papers 2023-14, Groupe de REcherche en Droit, Economie, Gestion (GREDEG CNRS), Université Côte d'Azur, France.

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