Optimal Monetary Policy in Production Networks

Jennifer La'O, Alireza Tahbaz-Salehi*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

This paper studies the optimal conduct of monetary policy in a multisector 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 optimal 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 greater 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.

Original languageEnglish (US)
Pages (from-to)1295-1336
Number of pages42
JournalEconometrica
Volume90
Issue number3
DOIs
StatePublished - May 2022

Keywords

  • Monetary policy
  • misallocation
  • nominal rigidities
  • production networks

ASJC Scopus subject areas

  • Economics and Econometrics

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