The Supply-Side Effects of Monetary Policy

93 Pages Posted: 19 Jan 2021 Last revised: 14 Jun 2023

See all articles by David Baqaee

David Baqaee

London School of Economics and Political Science, Department of International Development, Students

Robert B. Mendelson

Morgan, Lewis & Bockius, L.L.P.

Kunal Sangani

Harvard University

Date Written: January 2021

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 pass-throughs 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 micro-level predictions of our model.

Suggested Citation

Baqaee, David and Mendelson, Robert B. and Sangani, Kunal, The Supply-Side Effects of Monetary Policy (January 2021). NBER Working Paper No. w28345, Available at SSRN: https://ssrn.com/abstract=3768259

David Baqaee (Contact Author)

London School of Economics and Political Science, Department of International Development, Students ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/davidbaqaee/

Robert B. Mendelson

Morgan, Lewis & Bockius, L.L.P. ( email )

1800 M Street, NW
Washington, DC 20036-5869
United States

Kunal Sangani

Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

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