The Supply-Side Effects of Monetary Policy

David Baqaee, Emmanuel Farhi and Kunal Sangani

No 15702, CEPR Discussion Papers from Centre for Economic Policy Research

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 pass-through; Misallocation; Monetary policy (search for similar items in EconPapers)
JEL-codes: E0 L1 (search for similar items in EconPapers)
Date: 2021-01
New Economics Papers: this item is included in nep-cwa, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (27)

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Related works:
Journal Article: The Supply-Side Effects of Monetary Policy (2024)
Working Paper: The Supply-Side Effects of Monetary Policy (2021)
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