The Aggregate and Distributional Consequences of Large Monetary and Fiscal Interventions in the Face of Large Shocks

Abstract

We develop a framework for analyzing the effects of large macroeconomic shocks and policy interventions, by combining (i) heterogeneous households with incomplete markets and (ii) state dependent pricing by firms. We show that both features significantly influence the transmission of fiscal stimulus and monetary policy - heterogeneous households because of failures of Ricardian equivalence, and state-dependent pricing because of its non-linear effects on inflation. We use our framework to quantify how monetary and fiscal policy interventions shaped macroeconomic dynamics in response to the large shocks of 2020, and how alternative policy choices could have led to different aggregate and distributional outcomes. We find large departures from Ricardian equivalence and large stepping-on-a-rake effects of interest changes. The large unfunded fiscal transfer program helped prevent deflation in 2020 and significantly raised output throughout 2021 and 2022, but led to a large permanent rise in prices. The monetary easing through 2020 and 2021 also contributed to preventing deflation, but had a minimal impact on GDP. The monetary tightening from 2022 lowered the maximum inflation rate, but contributed to permanently higher prices. The welfare effects of these policies differed widely across the wealth distribution and represented net gains to low wealth households and net losses to high wealth households, but those welfare effects are due to incomplete markets for idiosyncratic risk not aggregate stabilization. Alternative commitments to funding fiscal stimulus could have achieved similar effects on short-term inflation and output with a much smaller long term increase in the price level, but at the cost of lower future output.

Joint paper with Ken Miyahara.