A Note on Temporary Supply Shocks with Aggregate Demand Inertia

Ricardo Caballero () and Alp Simsek

No 16814, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study optimal monetary policy during temporary supply contractions when aggregate demand has inertia and the central bank is concerned about future constraints on expansionary policy. In this environment, it is optimal to run the economy hot until supply recovers. However, the policy does not remain loose throughout the low-supply phase. Overall, when the initial aggregate demand is low, the goal is to frontload the rate cuts to raise demand in anticipation of the recovery of supply. If inflation also has inertia, the central bank still overheats the economy during the low-supply phase but gradually cools it down over time.

Keywords: Monetary policy; Backward guidance; Covid-19 (search for similar items in EconPapers)
JEL-codes: E21 E32 E43 E44 E52 G12 (search for similar items in EconPapers)
Date: 2022-06
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Journal Article: A Note on Temporary Supply Shocks with Aggregate Demand Inertia (2023)
Working Paper: A Note on Temporary Supply Shocks with Aggregate Demand Inertia (2022)
Working Paper: A Note on Temporary Supply Shocks with Aggregate Demand Inertia (2022)
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