Working Paper: CEPR ID: DP15702
Authors: David Rezza Baqaee; Emmanuel Farhi; Kunal Sangani
Abstract: We propose a supply-side channel for the transmission of monetary policy. We show that if, as is consistent with the empirical evidence, bigger firms have higher markups and lower pass-throughs than smaller firms, then a monetary easing endogenously increases aggregate TFP and improves allocative efficiency. This endogenous positive “supply shock” amplifies the effects of the positive “demand shock” on output and employment. The result is a flattening of the Phillips curve. This effect is distinct from another mechanism discussed at length in the real rigidities literature: a monetary easing leads to a reduction in desired markups because of strategic complementarities in pricing. We calibrate the model to match firm-level pass-throughs and find that the misallocation channel of monetary policy is quantitatively important, flattening the Phillips curve by about 70% compared to a model with no supply-side effects. We derive a tractable four-equation dynamic model and show that monetary easing generates a procyclical hump-shaped response in aggregate TFP and countercyclical dispersion in firm-level TFPR. The improvements in allocative efficiency amplify both the impact and persistence of interest rate shocks on output.
Keywords: Productivity; Incomplete Passthrough; Misallocation; Monetary Policy
JEL Codes: E0; L1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary easing (E52) | Endogenous positive supply shock (E65) |
| Endogenous positive supply shock (E65) | Aggregate total factor productivity (TFP) (E23) |
| Monetary easing (E52) | Allocative efficiency (D61) |
| Allocative efficiency (D61) | Aggregate total factor productivity (TFP) (E23) |
| Demand shocks (E39) | Resource allocation across firms (D22) |
| Resource allocation across firms (D22) | Productivity changes (O49) |
| Monetary easing (E52) | Output (Y10) |
| Monetary easing (E52) | Employment (J68) |
| Misallocation channel (D61) | Flattening of the Phillips curve (E31) |
| Monetary shocks (E39) | Aggregate total factor productivity (TFP) (E23) |