Working Paper: CEPR ID: DP16971
Authors: Luca Fornaro; Federica Romei
Abstract: We study optimal monetary policy during times of exceptionally high global demand for tradable goods, relative to non-tradable services. The optimal monetary response entails a rise in inflation, which helps rebalance production toward the tradable sector. While the inflation costs are fully beared domestically, however, part of the gains in terms of higher supply of tradable goods spill over to the rest of the world. National central banks may thus fall into a coordination trap, and implement an excessively tight monetary policy during tradable goods-driven recoveries.
Keywords: Asymmetric shocks; Reallocation; Monetary policy; International monetary cooperation; Inflation; Global supply shortages
JEL Codes: E32; E44; E52; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal monetary policy during periods of high global demand for tradable goods (F41) | rise in inflation (E31) |
| rise in inflation (E31) | rebalancing production toward the tradable sector (F16) |
| rise in inflation (E31) | higher employment in both tradable and nontradable sectors (J68) |
| monetary expansion (E50) | rise in the price of tradables (F16) |
| rise in the price of tradables (F16) | higher employment in both tradable and nontradable sectors (J68) |
| monetary expansion (E50) | increase in aggregate demand (E00) |
| lack of international cooperation (F55) | excessive unemployment during tradable goods-driven recoveries (J64) |
| global reallocation shock (F69) | depress demand for nontradables (F16) |
| monetary policy response (E52) | higher prices in the tradable sector (F16) |
| monetary expansion under financial autarky (E19) | stronger positive impact on aggregate demand (E00) |
| monetary expansion under free capital mobility (F32) | benefits partly enjoyed by foreign consumers (F61) |