The Supply-Side Effects of Monetary Policy

Abstract

We propose a supply-side channel for the transmission of monetary policy. We show that in an economy with heterogeneous firms and endogenous markups, demand shocks such as monetary shocks have a first-order effect on aggregate productivity. If high-markup firms have lower passthroughs than low-markup firms, as is consistent with empirical evidence, then a monetary easing reallocates resources to high-markup firms and alleviates misallocation. Consequently, positive "demand shocks" are accompanied by endogenous positive "supply shocks" that raise output and productivity, lower inflation, and flatten the Phillips curve. We derive a tractable four-equation dynamic model and use it to show that monetary shocks generate a procyclical hump-shaped response in TFP and endogenous cost-push shocks in the New Keynesian Phillips curve. A calibration of our model suggests that the supply-side effect increases the half-life of a monetary shock's effect on output by about 30% and amplifies the total impact on output by about 70%. Using identified monetary shocks, we provide empirical evidence for both the macro-and microlevel predictions of our model.

Firm Heterogeneity, Capital Misallocation and Optimal Monetary Policy

“…Our algorithm is simple to code using Dynare and can be easily generalized to other problems. Zanetti and Hamano (2020), Andrés et al, 2021, Nakov and Webber, 2021or Baqaee et al, 2021, in cyclicality (David and Zeke, 2021) or in firm-level productivity trends (Adam and Weber, 2019).…”