(Econometrica, July 2023)
(Econometrica, July 2023)
This paper revisits the New Keynesian framework, theoretically and quantitatively, in an economy with multiple sectors and input‐output linkages. Analytical expressions for the Phillips curve and welfare, derived as a function of primitives, show that the slope of all sectoral and aggregate Phillips curves is decreasing in intermediate input shares, while productivity fluctuations endogenously generate an inflation‐output tradeoff—except when inflation is measured according to the novel divine coincidence index. Consistent with the theory, the divine coincidence index provides a better fit in Phillips curve regressions than consumer prices. Monetary policy can no longer achieve the first‐best, resulting in a welfare loss of 2.9% of per‐period GDP under the constrained‐optimal policy, which increases to 3.8% when targeting consumer inflation. The constrained‐optimal policy must tolerate relative price distortions across firms and sectors in order to stabilize the output gap, and it can be implemented via a Taylor rule that targets the divine coincidence index.
(Annual Review of Economics, September 2023)
This paper reviews a framework for studying the aggregation and propagation of microeconomic shocks in general equilibrium. We discuss the determinants of aggregate measures of real economic activity, like real GDP, real domestic absorption, and aggregate productivity in both efficient and inefficient environments. We also discuss how shocks from one set of producers are transmitted to other producers through prices and quantities. The framework we provide is amenable to generalization and can be used to study any collection of producers ranging from one isolated producer, to an industry consisting of heterogeneous producers, to an entire economy. We conclude with a brief survey of some of the applied questions that can be addressed using the analytical tools presented in this review and avenues for future work.
The Covid pandemic triggered high inflation alongside large relative price movements. Was inflation the consequence of efficient relative price adjustments, or did it arise from aggregate demand mismanagement? Conventional models feature no link between relative prices and aggregate inflation. I enrich the New Keynesian framework with multiple industries and imperfectly substitutable primary factors. With multiple industries, efficient relative prices depend on industry-specific TFP shocks; with multiple factors, they depend on demand shocks and capacity constraints. When supply or pricing elasticities differ across industries, a two-way causality arises: efficient relative price changes create an inflation-output tradeoff, and aggregate demand affects relative prices. Therefore one cannot infer the contribution of relative price shocks from reduced-form correlations. Inverting the model yields re-weighted price indices that identify industry-specific versus aggregate drivers and enable forecasting. In the US, industry-specific shocks dominated in 2020; aggregate factors prevail since 2021.
This paper connects the industry composition of government spending with household-level and aggregate multipliers. In a general analytical framework, it shows that the industry composition of government spending matters only if factor markets are segmented and industries use different combinations of primary factors (labor occupations and capital assets). By changing the relative demand for primary factors, government spending redistributes income across households. Moreover, shifting demand toward factors with flatter supply curves expands aggregate supply, yielding larger multipliers. Quantitatively, aggregate multipliers vary from 0.3 to 0.7 across target industries. Variation across employment and income responses is one order of magnitude larger.
This paper models the incidence of aggregate demand shocks on relative labor income across households. Incidence patterns are central to policy debates and to aggregate monetary transmission. Building a New Keynesian framework with multiple industries and segmented labor markets, I find that labor income responses follow a Phillips curve logic. Workers and industries facing more nominal rigidity or more elastic factor supply exhibit larger employment responses and smaller price responses to aggregate demand. The model rationalizes several empirical patterns. Low-income occupations face stronger employment cyclicality through more elastic labor supply, while high-income occupations face stronger earnings cyclicality through more flexible compensation. When properly accounting for capital-skill complementarities, the model generates a U-shaped incidence across the wage distribution. The development of new technologies that substitute mid-skill occupations would reverse the incidence profile, dampening aggregate monetary transmission.
I propose a novel partial equilibrium theory of the fragmentation of production across industries, in an environment where firms have variable input requirements over time, while workers have different comparative advantage over inputs and cannot be freely reallocated across firms. Fragmenting production allows firms to allocate workers to tasks at all times according to their comparative advantage, but it requires costly trading of inputs between firms. I show that, in general equilibrium, there is a two-way relationship between technical change, fragmentation, and the wage distribution. On the one hand, reducing the cost of trading inputs between firms implies a hollowing out of the wage distribution. On the other hand, a rise in the skill premium strengthens the incentives to fragment production. The model shows that skill biased technical change not only affects the wage distribution, but also the organization of production. Moreover, the theory suggests that outsourcing – which is a form of fragmentation – could be the consequence as well as the cause of a higher skill premium.
In a disaggregated economy with multiple industries, primary factors, and final users, I show how to map micro-level demand, supply, and price elasticities into macro-level elasticities that govern the evolution of factor prices and quantities. I first characterize macro demand and supply elasticities, which describe the slopes of a factor supply equation and a relative factor demand equation. I then derive general equilibrium elasticities which govern the response of endogenous variables to exogenous shocks. For each elasticity, I isolate four components corresponding to all combinations of aggregate and cross-sectional shocks and outcomes. I find that cross-sectional shocks can have aggregate effects in general equilibrium – and vice versa – whenever primary factors have heterogeneous supply elasticities or factor prices have heterogeneous passthrough into aggregate prices. I apply the framework to illustrate the aggregate and redistributive effects of several demand and supply shocks, such as monetary policy, fiscal policy, biased productivity changes, and changes in trade costs.
When estimating the relation between macroeconomic aggregates, identification is often confounded by the policy response to changes in these aggregates. Estimating the same relations at the local level avoids the issue, because macroeconomic policies do not respond to local conditions. I show that the traditional version of this argument is valid only if all local variables respond to aggregates with equal elasticities – an assumption which cross-sectional studies always maintain, and which is violated in practice. This assumption guarantees that all the variation comes from local shocks, and it delivers a simple mapping between cross-sectional and aggregate elasticities. If the assumption is violated, part of the cross-sectional variation is driven by aggregate shocks. Relative local responses to these shocks are informative of cross-sectional variation in local parameters, rather than of the aggregate parameters of interest. I propose an alternative method to exploit cross-sectional variation in response to an identified shock, combined with a calibrated structural model, to filter out the endogenous response of macroeconomic policies and obtain unbiased estimates of some model parameters, which in turn can be mapped into the aggregate elasticities of interest using the model.
I consider a global production network, where every country has multiple sectors that
trade in intermediate inputs both domestically and internationally. Producers in each countrysector
pair can price different shares of their output in different currencies, also conditioning
on the destination. I derive the response of local inflation and output to local and
foreign shocks to sector-level productivity, monetary policy and exchange rates. I plan on
using this framework to revisit traditional questions, such as the effect of competitive devaluations
and monetary policy spillovers, and to evaluate the extent to which an increase
in import shares (both in production and final consumption) can reduce the sensitivity of
inflation to local employment.