Optimal Monetary Policy in Production Networks
54 Pages Posted: 12 Dec 2019 Last revised: 24 Sep 2020
Date Written: November 16, 2019
This paper studies the optimal conduct of monetary policy in a multi-sector economy in which firms buy and sell intermediate goods over a production network. We first provide a necessary and sufficient condition for the monetary policy’s ability to implement flexible-price equilibria in the presence of nominal rigidities and show that, generically, no monetary policy can implement the first-best allocation. We then characterize the constrained-efficient policy in terms of the economy’s production network and the extent and nature of nominal rigidities. Our characterization result yields general principles for the optimal conduct of monetary policy in the presence of input-output linkages: it establishes that optimal policy stabilizes a price index with higher weights assigned to larger, stickier, and more upstream industries, as well as industries that face stronger strategic complementarities in price setting.
Keywords: monetary policy, production networks, nominal rigidities, misallocation
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