Working Paper

Limited (Energy) Supply, Monetary Policy, and Sunspots

Abstract: In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

Keywords: Supply constraints; Heterogeneous households; Monetary transmission; Transfer multiplier; Sunspots;

JEL Classification: E31; E32; E52; F41; Q43;

https://doi.org/10.17016/IFDP.2024.1395

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2024-08-27

Number: 1395