Optimal Monetary Policy in Production Networks

55 Pages Posted: 7 Jul 2020

Date Written: July 2020

Abstract

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 with less sticky upstream suppliers but stickier downstream customers. In a calibrated version of the model, we find that implementing the optimal policy can result in quantitatively meaningful welfare gains.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Suggested Citation

La’O, Jennifer and Tahbaz-Salehi, Alireza, Optimal Monetary Policy in Production Networks (July 2020). NBER Working Paper No. w27464, Available at SSRN: https://ssrn.com/abstract=3644065

Jennifer La’O (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Alireza Tahbaz-Salehi

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
2
Abstract Views
49
PlumX Metrics