Excess stimulus and monetary policy

Christopher Cotton

Economics Bulletin, 2023, vol. 43, issue 3, 1528 - 1538

Abstract: Stimulus checks are seen increasingly as a crucial method of stimulating the economy in downturns. In early 2021, US households received stimulus amounting to 7.5 percent of their median annual income. I show, however, that it is difficult for a central bank to avoid overshooting its inflation target when credit-constrained households receive moderate excess stimulus. I find that if credit-constrained households receive excess stimulus equal to 1 percent of their median annual income, nominal interest rates must rise by 1 to 3 percentage points to prevent above-target inflation. This poses challenges to central bank credibility. I also find price-level targeting responds better than a Taylor rule to excess stimulus. In early 2021, US households received stimulus amounting to 7.5 percent of their median annual income. I show, however, that it is difficult for a central bank to avoid overshooting its inflation target when credit-constrained households receive moderate excess stimulus. I find that if credit-constrained households receive excess stimulus equal to 1 percent of their median annual income, nominal interest rates must rise by 1 to 3 percentage points to prevent above-target inflation. This poses challenges to central bank credibility. I also find price-level targeting responds better than a Taylor rule to excess stimulus.

Keywords: stimulus checks; monetary policy; excess stimulus (search for similar items in EconPapers)
JEL-codes: E5 E6 (search for similar items in EconPapers)
Date: 2023-09-30
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