SMU SOE Seminar Series (October 15, 2024): Optimal Monetary Policy in Production Networks with Distortions

TOPIC:

ABSTRACT

This paper studies optimal monetary policy in a multi-sector economy with input-output linkages and distortions. Our model incorporates both supply-side and demand-side effects of monetary policy. We derive a tractable sufficient statistic for the supply-side effect, which comprises two reallocation channels resulting from substitution in production and from substitution in consumption. The optimal monetary policy induces an inflation bias stemming from both an aggregate wedge and the supply-side effect, and stabilizes an inflation index by assigning higher weights to (i) larger sectors, (ii) sectors with stickier prices, and (iii) sectors with less distortions. Our quantitative results indicate that produc-tion networks play a crucial role in generating both supply-side and demand-side effects of monetary policy.

Keywords: Production Networks, Optimal Monetary Policy, Supply-Side Effect, Phillips Curves, Stabilization Policy.

JEL Codes: E12, E31, E52, E58.

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