When Do Persistent Supply Shocks Call for Hawkishness?

Central banks typically rely on the following heuristic: Look through transitory supply shocks to stabilize the output gap, but pivot toward inflation stabilization when supply shocks become persistent. Yet standard macroeconomic models provide little support for this heuristic. They justify it for markup shocks—a particular type of supply disturbance—but imply that, for the most common supply shocks, such as productivity, labor supply, or energy prices, stabilizing the output gap remains close to optimal even when these shocks are persistent. What, then, rationalizes a hawkish response to persistent supply shocks? This paper shows that, contrary to conventional wisdom, the risk that inflation expectations de-anchor is not sufficient. Even when expectations are backward-looking, output-gap stabilization remains close to optimal. Instead, real wage rigidity emerges as the key mechanism. When real wages are sufficiently rigid, stabilizing the output gap becomes substantially more costly, and optimal policy shifts toward inflation stabilization in response to persistent supply shocks, regardless of whether expectations can de-anchor. These findings suggest that monitoring real wage rigidity may be at least as important as monitoring inflation expectations when assessing the need for a hawkish policy pivot.