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Excess stimulus and monetary policy

Author

Listed:
  • Christopher David Cotton

    (Federal Reserve Bank of Boston)

Abstract

Stimulus checks are seen increasingly as a crucial method of stimulating the economy in downturns. In early 2021, US households received stimulus amounting to 7.5 percent of their median annual income. I show, however, that it is difficult for a central bank to avoid overshooting its inflation target when credit-constrained households receive moderate excess stimulus. I find that if credit-constrained households receive excess stimulus equal to 1 percent of their median annual income, nominal interest rates must rise by 1 to 3 percentage points to prevent above-target inflation. This poses challenges to central bank credibility. I also find price-level targeting responds better than a Taylor rule to excess stimulus. In early 2021, US households received stimulus amounting to 7.5 percent of their median annual income. I show, however, that it is difficult for a central bank to avoid overshooting its inflation target when credit-constrained households receive moderate excess stimulus. I find that if credit-constrained households receive excess stimulus equal to 1 percent of their median annual income, nominal interest rates must rise by 1 to 3 percentage points to prevent above-target inflation. This poses challenges to central bank credibility. I also find price-level targeting responds better than a Taylor rule to excess stimulus.

Suggested Citation

  • Christopher David Cotton, 2023. "Excess stimulus and monetary policy," Economics Bulletin, AccessEcon, vol. 43(3), pages 1528-1538.
    • Handle: RePEc:ebl:ecbull:eb-23-00101
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    References listed on IDEAS

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    1. Olivier Coibion & Yuriy Gorodnichenko & Michael Weber, 2020. "How Did U.S. Consumers Use Their Stimulus Payments?," Working Papers 2020-109, Becker Friedman Institute for Research In Economics.
    2. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    3. Nicholas S. Souleles, 1999. "The Response of Household Consumption to Income Tax Refunds," American Economic Review, American Economic Association, vol. 89(4), pages 947-958, September.
    4. Òscar Jordà & Celeste Liu & Fernanda Nechio & Fabián Rivera-Reyes, 2022. "Why Is U.S. Inflation Higher than in Other Countries?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, vol. 2022(07), pages 1-06, March.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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