Reallocation Effects of Monetary Policy

Abstract

Responding to the increased attention on the distributional aspects of monetary policy, we investigate the reallocation among heterogeneous firms triggered by nominal growth. Japanese firm-level data show that large firms invest more in R&D and grow faster than small firms under higher inflation. We then construct a model that introduces nominal rigidity into R&D-driven endogenous growth with heterogeneous firms. The model shows that high nominal growth leads to an increase in the market share of innovative firms because menu-cost burdens are relatively heavier for less innovative firms. This reallocation effect yields a positive effect of monetary expansion on both real growth and welfare. The optimal nominal growth can be strictly positive even under nominal rigidity. Moreover, the presence of menu costs can improve welfare.

Monetary Policy, Markup Dispersion, and Aggregate TFP

“…Whereas we show that the former lowers misallocation, Gopinath et al (2017) show that the latter increases misallocation through size-dependent financial frictions. Relatedly, Oikawa and Ueda (2018) study the long-run effects of nominal growth through reallocation across heterogeneous firms.…”

Inflation, innovation, and growth: A survey

“…They compute the welfare-maximizing and grow-maximizing inflation rates and find that their difference is determined by the extent of R&D overinvestment in the economy. Miyakawa et al (2021) introduce sticky prices and menu costs to the Schumpeterian growth model with heterogeneous multiproduct firms developed by Klette and Kortum (2004) and extended by Lentz and Mortensen (2008) and find that the optimal inflation rate can be positive by causing quality-superior firms (i.e., firms with a larger number of products) to grow and quality-inferior firms to exit. Benigno and Fornaro (2018) consider a Schumpeterian growth model with sticky wages and show an important result that the economy features a stagnation trap, in which monetary policy is ineffective in stimulating the economy.…”