The Power of Persistence: How Demand Shocks and Monetary Policy Shape Macroeconomic Outcomes

Fabrice Collard, Patrick Fève and Philipp Wangner

No 25-1616, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: This paper explores how the persistence of demand shocks interacts with monetary policy in New Keynesian frameworks. We identify two key propagation channels: a permanent income channel, which amplifies the effects of persistent shocks, and a real interest rate channel, which goes in the opposite direction. The balance between these forces depends critically on the aggressiveness of the central bank’s response to inflation, giving rise to distinct monetary policy regimes. Under accommodative policies, persistence magnifies the response of output, while aggressive policies dampen these effects. In the intermediate regime, a hump-shaped relationship emerges between persistence and the response of output. Our analysis extends to medium-scale DSGE models, featuring capital accumulation, household heterogeneity, behavioral frictions, working capital, nominal wage and price rigidities, revealing that these dynamics are remarkably robust.

Keywords: Persistence; Demand Shocks; Monetary Policy; New Keynesian Model (search for similar items in EconPapers)
Date: 2025-02
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:tse:wpaper:130328

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