Monetary Policy Under Hysteresis
Last Draft: Coming Soon
Abstract: Recent evidence suggests that monetary policy persistently affects labor and total factor productivity and can be non-neutral in the longer run. This paper studies policy implications of the long-run monetary non-neutrality as well as possible sources of why monetary policy can influence the economywide productivity in the first place. Using the data on labor market conditions in R&D intensive sectors of the U.S. economy I document that restrictive monetary policy significantly depresses labor hours in these sectors which can be viewed as possible explanation for the former observation. I then develop a business cycle model extended with endogenous technological knowledge formation mechanism and endogenous growth. Using this model I estimate that the long-run losses from 1 p.p. nominal interest rate hike can reach up to 2.8-6.8% of the pre-hike level of output. Under hysteresis central bank's priorities should be shifted away from inflation stabilization goal toward the objective of stabilizing the output instead. The optimal (Ramsey) policy regime implies a decisive nominal interest rate cut in response to negative inflationary shock. The optimized simple policy rule requires substantially higher weight on the GDP growth term in the central bank's reaction function though this does not fully allow the latter to achieve the dynamics of the main macroeconomic aggregates implied by the optimal (Ramsey) policy regime conditional on negative inflationary shock.