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Monetary policy with endogenous aggregate productivity and misallocation

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  • Hannikainen, Lauri

Abstract

Standard New Keynesian models treat aggregate total factor productivity as exogenous to monetary policy. This paper studies optimal monetary policy in the four-equation New Keynesian model of Baqaee, Farhi, and Sangani (2024), in which monetary expansions reallocate resources toward high-markup firms, reduce misallocation, and raise aggregate productivity. This endogenous productivity response flattens the Phillips curve and changes the optimal target criterion of a dual-mandate central bank. The resulting criterion is both forward- and backwardlooking. In my calibration, this criterion is closely approximated by a familiar New Keynesian target criterion adjusted only for the flatter Phillips curve. By contrast, applying a standard target criterion that ignores the effect of monetary policy on aggregate productivity leads the dual-mandate central bank to stabilize inflation too aggressively and generates excessive output fluctuations.

Suggested Citation

  • Hannikainen, Lauri, 2026. "Monetary policy with endogenous aggregate productivity and misallocation," Bank of Finland Research Discussion Papers 8/2026, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:343109
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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