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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. 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.
    2. 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.
    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.
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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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