Monetary Policy

(JOB MARKET PAPER) I develop a New Keynesian model with input–output linkages, search-and-matching frictions, and sticky prices to study how shocks propagate to output and inflation. Hiring costs tie firms’ marginal costs to local labor market tightness, creating a labor market propagation channel—distinct from input-price spillovers—by which higher demand in one sector raises wages and job-finding rates in that sector, redirects job search across sectors, and increases hiring costs elsewhere. Solving the model nonlinearly yields a Phillips curve that steepens as tightness rises, consistent with recent evidence, implying weaker output effects and stronger inflation responses to monetary policy when some sectors are tight.

In standard New Keynesian models, future interest rate cuts have larger effects than current cuts—this is called the forward guidance puzzle. We argue that the forward guidance puzzle is not a puzzle. We show the puzzle arises from an implausibly large monetary regime change, exceeding anything in U.S. history since the Great Depression. By calibrating our model to four regime changes during the U.S. Great Depression, disciplined by changes in long-term bond yields, we find the model’s predictions are broadly consistent with historical data.