Analyses & Studies • Publications
When Do Persistent Supply Shocks Call for Hawkishness?
What justifies a hawkish response to persistent supply shocks?
A common central-bank heuristic is to look through transitory supply shocks in order to stabilize the output gap, but to pivot toward inflation stabilization when shocks are persistent and inflation expectations may de-anchor.
Yet standard models provide little support for this heuristic. For common supply shocks productivity, labor supply and energy prices stabilizing the output gap remains close to optimal even when shocks are persistent.
The paper shows that, contrary to conventional wisdom, this remains true when expectations can de-anchor. Expectations de-anchoring risks alone do not provide a strong rationale for a hawkish pivot.
Instead, the rationale lies in real wage rigidity. When real wages are sufficiently rigid, stabilizing the output gap becomes much more costly, and optimal policy shifts toward stabilizing inflation as shocks become more persistent.
Key takeaway: monitoring real wage rigidity is at least as important as monitoring inflation expectations when assessing the need for a hawkish policy response.
Read the full paper here: https://lnkd.in/dcHevpcr
